In case you weren't following the news -- well, the financial news -- the Dow dropped 832 points on Wednesday, Oct. 10, throwing investors into an all-out tizzy and spiking fears that a major sell-off was upon us. If you were smart, you didn't subject yourself to the torture of logging on and viewing your portfolio balance that day. But seeing as how I've always been a glutton for punishment, curiosity got the better of me, so I accessed my brokerage account to see how I'd fared, and lo and behold, my portfolio value had dropped $10,000. In a single day.
The funny thing, however, is that not only was I not shocked, but I also wasn't particularly panicked. And if you take the time to understand how the stock market works, you won't worry the next time your investments lose value, either.
Volatility is normal
There's a reason stocks have historically offered investors substantially higher returns than bonds in the long run -- there needs to be an upside to the risk they carry. Bond values, by contrast, don't tend to fluctuate as violently as stock values, but on the flip side, they won't help you grow wealth the same way stocks will. Not even close.
So let's talk about last week's plunge, because at face value, it was pretty brutal. But one thing you must realize about the stock market is that such volatility is completely normal.
Since 1950, the S&P 500 -- a bucket of 500 of the largest U.S. stocks and a major indicator of the market's overall performance -- has experienced a correction in which values fell 10% or more on 36 separate occasions. That's about once every two years. But of those 36, 22 have resolved within 104 days -- not a terribly long period to wait out. And several of those corrections resolved within a month.
That's precisely why I didn't panic on Wednesday, when I saw that my portfolio had lost $10,000 in value in a single day's time. First of all, we didn't experience a full-fledged correction at that time. Secondly, I knew that if I sat back and remained patient, there was a good chance that number would climb back up over the course of the week. And it did, to an extent. I'm still down about $5,000 in value as of this writing, but that's certainly better than $10,000.
But the real reason I didn't lose my cool that day was that I knew that, until I sell off investments, I won't actually lose any money. It's a concept known as a loss on paper, which comes from days when brokerage account statements came in paper form. Nowadays, investors are more likely to experience a loss on screen than on paper, but the point is that when all you're seeing is a decline in investment value, it's not an actual monetary loss. It only becomes a financial loss when you act irrationally and sell investments at a price that's lower than what they were once worth.
Therefore, let this be a lesson: Your goal in investing should be to load up on the right stocks (those issued by solid companies with a history of outstanding performance) and hold them for as many years as you can. If you take that approach, you won't panic the next time the market has a day like the one we all experienced that fateful Wednesday. And make no mistake about it: We will have another day like that, and it possibly may be much worse. But if you know what you're doing, you won't sweat it.