The Stock Market Correction: Is the Worst Already Over?

The following is an excerpt from The Motley Fool newsletter “Bilanz Ziehen.” Simply click here to register for free.

“Most of the correction is behind us.”

That was the headline.

“What a relief!” I thought. “Since the beginning of July, we’ve watched the DAX surge above 10,000 for the first time, fall 10% to around 9,000, climb back to 9,800, and then sink to less than 9,000. But now we know… we know!… that most of the correction is behind us, so it’s safe for us to start investing again.”

Naturally, I’m joking. The market has fallen significantly in the past month, but good luck trying to predict what that means for the next month.

The short-term ups and downs of the market are essentially impossible to predict, despite the obsession that consumes many investors as they try to figure out how squiggles in the market and marketing-timing “signals” will lead to a correct prediction of what happens over the course of a few months.

To be sure, sometimes those investors are correct. At least, as far as their prediction matching the market’s outcome. But that’s usually a “correct” in the way a broken clock is right twice every day.

It’s going to be hot

Let’s say you’re moving to Hawaii. Lucky you! And you’re going to live there for at least the next five years.

Now consider this: How are you going to pick out your new wardrobe? Are you going to try to predict what the weather will be next week and buy your entire new wardrobe based on that? Stranger still, will you continuously try to predict the temperature a week or a month out and buy clothes (and get rid of others) based on those forecasts?

I’d guess not.

More likely, you’d go to a website that has weather data for Hawaii and consider the average temperatures throughout the year. If you did that, you’d see that over the course of an typical year, the average high temperature in Honolulu is consistently above 27 degrees, and the average low doesn’t get below 18 degrees. With that information in hand, you’d probably spend most of your wardrobe budget on shorts and t-shirts rather than parkas and snow pants.

Of course, you may also notice that historical low temperatures in Honolulu have gone down to 4 degrees. So you’d be wise to include some warm clothes in your closet and know that even though you’re living in paradise, every so often you’re going to be chilly.

You know where I’m going with this

Fool.de isn’t a weather site, vacation column, or fashion publisher. So you’ve certainly guessed by now that Hawaii is simply a metaphor for your investing.

Based on data from the Deutsches Aktieninstitut, the DAX has returned an average of 7.3% per year over the last 50 years. That’s a Hawaiian paradise for investors that would have turned 100,000 EUR into 3.4 million EUR over that 50-year period.

Just as with the real Hawaii though, there were some cold snaps in there. The DAX fell a chilling 36.4% in 1986. In 2001 it was downright frosty with a drop of 43.9%. 2007 delivered another annual loss of more than 40%. And yet, the “average temperature” of the DAX over the last 50 years, including all of those terrible years, was still that balmy +7.3% per year. And it’s been even better for shorter stretches – over the past 35 years, the DAX has returned 9.5% per year.

So here’s the question: If you’re picking out your investing strategy, do you think you should do it based on guesses about what will happen next week or next month? Or would it be wiser to think bigger picture? Over time, businesses have grown, the German economy has grown, and the world economy has grown. That’s driven business values up, and with it the overall value of world stock markets.

Sure, it gets cold on the market sometimes, but if you keep perspective, you’ll remember that you’re living in a tropical investor’s paradise.

What does that mean for today?

While this may be the right way to think about investing from a high level, we still need to know what to do on a day-to-day or month-to-month basis. The good news is that, most of the time, you’re best off doing nothing and just letting your investments work for you.

That doesn’t necessarily change when the market hits a losing streak. But there are a few specific things worth considering during an episode like this:

1. Money on the sidelines – Do you have a lot of cash sitting idle? As I laid out above, we can’t say that the market is done falling. What is guaranteed though, is that, as of Thursday at least, the DAX is 12% cheaper now than it was on September 20. Even if this isn’t an “all in” moment, it could be an opportunity to put some extra cash to work. Though you don’t have to wait for a market drop to do that — as the great U.S. investor Shelby Davis once said, “The best time to invest is when you have the money.”

2. That uneasy feeling – If you find yourself feeling uneasy during a falling market, there are a couple of things that could be happening. First, it may just be the common human reaction to losses — behavioral finance experts have said that we’re wired to be twice as psychologically hurt by losses as we are happy about gains. So a falling market will naturally feel uncomfortable. If you think this is the case, skip ahead to No. 3.

It’s also possible that you don’t own the right investments for your situation. If a falling market is making you pull out your hair over your investments, you may have taken on too much risk. If you think this is the case, panic during a falling market isn’t the right answer. However, revisiting your investing approach and deciding on a more appropriate risk level may be wise.

3. Don’t do anything at all – This is the answer that will apply to most people. In the short term, the market goes up, and the market goes down. But over longer timeframes, the market has tended to go up. It’s natural to feel a little uneasy when you see red in your portfolio, and that can lead to bad, emotional decisions — like selling at the bottom.

As a result, the very best thing you can do might be to shut down the computer, turn off the TV, and focus on something else, like going for a hike, seeing a movie, or … planning a trip to Hawaii.