Let's face it: It's been a terrible year to be long stocks for the long term. And since that's predominantly what we practice and preach here at The Motley Fool, by virtue of the transitive property, I can say that it's been a pretty terrible year to be a Fool.
Indeed, we've had longtime members question our mettle, and we've been inundated by requests to offer more guidance on how to play defense. But this article isn't about The Motley Fool. It's about you, and how you can make sure you're in position to make money when this terrible market environment turns around.
The perils of recency
There was and is a reason why we Fools are predominantly long stocks of high-quality businesses for the long term: It's a time-tested strategy that works.
Warren Buffett learned that lesson early in his partnership with Charlie Munger, and it's helped other successful investors, such as Chuck Akre, the team at Dodge & Cox, and Phil Fisher achieve market-beating returns over time.
It may not seem true today, but that's only because your brain has a bias toward recency -- it thinks that whatever has happened most recently will happen next. And in a market like this, that means your brain is busy scaring you into thinking the market can do nothing but drop.
There will definitely be times like these, when stocks drop dramatically and test your mettle. But if you remain disciplined, practice dollar-cost averaging, and allocate your invested assets between stocks and bonds in a way that respects your time horizon (more on that in a minute), you will succeed over time.
As Warren Buffett has said, "The most important quality for an investor is temperament, not intellect."
The turnaround you won't see coming
When stocks recover (and they will recover), they will do so dramatically and without warning. For evidence, look at this table of market downturns from Brandes Investment Partners, which was recently reproduced in an outlook from the superior investors at West Coast Asset Management:
| Period | Market Decline | DJIA Change 1 Year After Decline | DJIA Change 2 Years After Decline (cumulative) |
|---|---|---|---|
| Dec. 1961 – June 1962 | -27.1% | +32.3% | +55.1% |
| Feb. 1966 – May 1970 | -36.6% | +43.6% | +53.9% |
| Jan. 1973 – Dec. 1974 | -45.1% | +42.2% | +66.5% |
| Sep. 1976 – Feb. 1978 | -26.9% | +9% | +15.1% |
| Aug. 1987 – Oct. 1987 | -36.1% | +22.9% | +54.3% |
| July 1990 – Oct. 1990 | -21.2% | +26.2% | +32.6% |
| Jan. 2000 – March 2003 | -35.8% | +34.6% | +43.2% |
| Average | -32.7% | +29.4% | +45.8% |
| Oct. 2007 – Dec. 2008 | -46.7% | ? | ? |
Source: West Coast Asset Management.
Will you make back all of the money you've lost this year over the next two? It's unlikely, given that the market would have to nearly double from here to get back to its October 2007 high.
But it is likely that if you pull out of the market, you'll miss out on the recovery. And if that recovery resembles the magnitude of those we've seen before, missing out will add many years to the process of building back your wealth.
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