On Monday, the Dow plunged 725 points.
That was its steepest one-day loss since October.
And the S&P 500 and the tech-heavy Nasdaq had their biggest one-day declines since May.
Since then, stocks have bounced.
But when drops like these are happening, the talking heads on TV tend to run around with their hair on fire. That can put folks in panic mode.
And panic mode is the danger zone for us as investors.
When we’re scared, we do dumb things – like sell perfectly good stocks… and miss out on subsequent gains.
So in today’s dispatch, we’ll do three things…
Put this drop in context
Show why volatility like this is normal during summer and nothing to freak out about
Review some basic risk-management rules that will help you sleep easy in times of stock market turbulence
On Monday, the S&P 500 dropped 1.6%.
If you’re tuned in to cable news, that might seem like a big deal. But it’s small potatoes.
In an average year, the S&P 500 has about three pullbacks of 5%. And some years – like 2011… 2002… and 2000 – it has six.
So if you’re invested in stocks… and you can’t stomach a 1.6% drop… you’re in the wrong game.
Colleague Teeka Tiwari calls volatility the “price of admission for spectacular results.” And it’s a great way to think about it…
You see, the returns you earn on stocks are not a free lunch.
You earn money as an investor for shouldering the (sometimes wild) swings in stock prices.
That’s why bonds beat cash… stocks beat bonds… and crypto beats stocks. The higher the volatility you have to endure, the higher the returns on offer.
That’s worth keeping in mind right now.
As I mentioned, we see three 5% pullbacks for the S&P 500 in an average year. We haven’t had a 5% pullback since last October. So I (Chris Lowe) wouldn’t be surprised to see one soon.
Wall Street traders are going on vacation.
And like every year, they’re lightening up risk before they escape to the coast.
This leads stocks to perform poorly in the summer.
It’s something former Wall Street trader Jason Bodner has been digging into for readers of our Outlier Investor advisory.
He used to make trades worth upward of $1 billion for some of the world’s richest investors.
And he’s racked up gains of 163%… 254%… 307%… 324%… and 715% on stocks in the model portfolio for his subscribers.
Jason is a self-confessed data nerd. So he looked at S&P 500 returns for different parts of the year.
Here’s what he found…
For the September-to-December period, the S&P 500 had a negative return just 12% of the time.
By contrast, for the July-and-August period, the S&P 500 had a negative return 40% of the time.
And for the September-to-December period, the average gain for the index was 5%.
That plummeted to 0.4% for the July-and-August period.
These are averages. It’s possible for July and August to be good months for stocks. But your base case should be that they’ll stink compared with later in the year.
One thing you can be sure of with stocks is that they’ll go down as well as up.
Risk management is about limiting your downside risk. And it’s something every wealthy investor obsesses over.
The No. 1 risk-management rule we recommend to all our readers is to always be diversified.
That means never having 100% of your wealth in stocks – or any other asset class. Instead, you should have some money in stocks, some in real estate, some in gold and precious metals, some in cash, some in crypto, some in collectibles.
The more diversified you are, the less a single event – such as a stock market crash – can hurt your wealth.
The next most important risk-management rule is to keep a long-term time horizon.
The way to make real money in the markets is to get in on a market megatrend – early – and hold for the long haul.
That last part is crucial.
The S&P 500 is up more than 500% since the March 2009 low that followed the 2008 financial crisis.
But to earn those returns, you had to sit tight through the 2%… 5%… 10%… and 20% pullbacks along the way.
During the pandemic, I began a weekly video update with colleague Tom Beal.
It’s called The Weekly Pulse. It’s free to all Daily Cut readers. The aim is to bring you a deeper understand of the topics we track here at The Daily Cut in an easy-to-digest form.
You can find today’s Weekly Pulse update here.
I’d love your feedback on it. Is it useful? Do you enjoy the video format? What could Tom and I do to improve?
Write me at [email protected].
July 21, 2021