Stocks are diving, and you feel a sting of anxiety in your stomach when you read the headlines or visit your online bank.
How do you remain calm in that kind of market?
To be a successful investor, you have to avoid the natural human instinct to follow the herd.
When stocks plummet, your natural tendency is going to be to want to sell, and when the stock market is going up, your natural tendency is going to be to want to buy more.
In bubbles, you should be a seller, not a buyer. In busts, you should be a buyer.
You have to have the discipline to stomach the volatility of the stock market.
Here are seven key ways to develop the strength to go against the herd.
1. Be Financially Secure to Stomach any Volatility
First of all, you have to have some savings.
You’ve got to feel comfortable that you have enough money in the bank that you won’t need what you’ve invested for many years to come.
Some people think it’s a shame not to invest every penny that they have. In their world, cash not invested is a waste.
If that’s your thinking, I suggest you look at it this way instead: your cash savings are buying you something very valuable and specific, and that’s peace of mind and the ability to stomach market volatility. You should have at least two types of savings.
A. An emergency account for a car repair or a new fridge. This should be at least 5,000 USD that are always available.
B. A security savings of either three months’ salary or six months’ expenses. This should also be ready in cash. Apart from giving you peace of mind about the stock market, it will also make it easier for you to make some bold career moves and set boundaries at work.
2. Don’t Leverage
Don’t invest with borrowed money.
Most people know not to take out an expensive bank loan and invest that money or speculate with it.
But there is a different way of borrowing money that is not so obvious to the naked eye. Many platforms let you invest with leverage – almost without you noticing it: it’s called a margin account. Avoid this. You should never invest more than you have.
Investing with leverage has destroyed many good investors, even good value investors who were peers of Warren Buffett.
Call your brokerage platform to make sure that you’re only investing your own money if you’re not sure.
Some more complex financial products contain leverage, but if you are just selling and buying stocks, you are safe. Why is this important?
Leverage and debt makes you more vulnerable to panic and huge losses in a market with high volatility.
3. Remember: Volatility Happens to Everybody
Just because something goes down in value after you buy it, it doesn’t mean you’ve made an investing mistake.
Remember that no one is immune. We all sometimes see red numbers – it’s how you react that matters. Are you going to panic and turn it into a permanent loss or be cool?
Keep your focus on the long-term prospect.
The stock market moves up and down all the time. Volatility is just part of the game.
In the short term it’s a voting machine, whereas in the long term it’s a weighing machine.
It’s affected by all kinds of events in the world, and few of these events have anything to do with the business of the company that you are invested in. This is just the nature of volatility. But don’t worry, if your company is sound and has some competitive advantages, the stock price will straighten itself out in the long run.
If it’s any consolation, Warren Buffett has also invested in companies only to see the stock price drop further. One example is The Washington Post, which he invested in during the 1970s. More than a year after he initially invested in the newspaper, the stock price was down 25 percent.
This investment later turned into a profitable one. Four decades later, Buffett exited the position (the original investment of $10 million) in a tax-free swap worth more than $1 billion.
Volatility can really be your friend if you learn how to navigate in it.
4. Research Your Companies Like an Owner
Don’t buy a stock because someone in a podcast predicted high returns and a glorious future for the company.
Research the companies you invest in. Analyze it the way you would if you were buying the entire company.
- Make sure it’s a business you understand.
- Make sure you like the management.
- Make sure the company has some kind of competitive advantage.
- Make sure the company doesn’t have too much debt.
Thinking like a owner makes you more resistant to volatility jitters.
It’s a good idea to use some kind of checklist. You can borrow mine here.
5. Pay a Reasonable Price
The price of the stock should be reasonable compared with the earnings of the company.
I usually say “buy it when it’s cheap,” but I fear that many people will think a stock is cheap if it has fallen from a recent high, and that isn’t necessarily the case.
You really have to look at the value in the company and compare the stock price to that.
Let’s go back to The Washington Post for a moment. Warren Buffett had calculated that it was priced at 25 percent of the intrinsic value before investing in it. That’s like buying one dollar for 25 cents. That it fell to 20 cents on the dollar does not make the original investment bad. It means you might want to consider buying some more since it’s an even better investment now.
What if they have no earnings? Don’t invest in it then.
Companies with no earnings or negative earnings are too risky to invest in.
6. Distract Yourself
If you’ve followed the first five points and still feel uneasy, there is only one thing left to do: something else.
The time has come to distract yourself from the market volatility and entertain yourself with other things.
Whether it’s meeting up with a good friend, playing a match of tennis, hiking in nature, playing Monopoly with your kids, watching a show on Netflix, or just concentrating on your work, do it if it can take your mind off worrying about stocks.
If you’ve done all the right things, you can relax and enjoy life – even if the stock market is raging. Leave the fidgeting with the sell button to others.
7. The Very Last Resort: Outsource It
If you find it hard to distract yourself from market volatility and if have a hard time staying away from the panic button (selling at a loss), you may want to consider letting others invest for you.
As Warren Buffett says, investing doesn’t take a high IQ – it takes a calm attitude.
You may be smart and informed, but if you are nervous as a leaf in the wind, it’s going to be difficult for you to make wise investment decisions because the herd reaction can get you galloping.
Outsourcing the investment work is a solution to this. One method may be to invest the same amount each month in passive index funds, but this method doesn’t have much to do with value investing.
There are several funds worldwide with a value investing purpose (I run one based in Denmark). One easy option could be to buy shares in Berkshire Hathaway, but just as with any other public stock, you have to make sure that stock price is fair compared to the intrinsic value. Even the most wonderful company can become a horrible investment if the stocks are bought at an inflated level.
How do you know if the price of the stock is reasonable? If you want to learn how Warren Buffett calculates the value of companies, you are welcome to download my free e-book here.
