It happens every time.
Toward the end of long bull markets, when stocks finally begin to feel safe and everyone's making money, folks that are nervous about investing in the stock market finally begin to relax. They put their money in the market and, lo and behold, for a little while, they do well. They tell themselves they're in it for the long haul. They promise themselves that they won't be scared off by the inevitable "dip."
Then the "dip" finally comes. And they lose 10%-15% of their money. They don't feel great about that, and stocks don't seem like such a good idea anymore, but they hang in there. Stocks for the long run!
But then the dip becomes a "bear market" -- down 20%. And then it becomes a bad bear market -- down 30%. And then it becomes a once-in-a-generation bear market -- down 40%. And suddenly everyone is saying that stocks are going to fall another 50% from there because the world's headed to hell in a handbasket.
And, eventually, the folks who put their money in the market near the top can't take it anymore. So they yank their money out. Better to save what little they have left, they think, than to see all of their hard-earned savings get flushed down the drain.
For a few weeks or months, they feel vindicated: The stock market drops some more. But then it turns around and rallies, and a year later, disgusted, they note that if they had only hung in there, they'd be back to even. And they vow never to invest in stocks again.
This, unfortunately, happens to lots of casual investors. It happens, in part, because investors get bad investment advice. It also happens because investors haven't learned the history of the stock market and prepared themselves for its gut-wrenching volatility.
But the good news is, it doesn't have to happen. As long as investors understand how the market behaves and have a concrete plan for dealing with this volatility, they can actually benefit from market crashes rather than get destroyed by them.
In this video, I talk with advisor Mark Hebner of Index Funds Advisors about how IFA has handled the past decade. Like other disciplined asset managers, IFA constructs portfolios designed to match the risk-tolerance of each individual investor and then uses portfolio rebalancing to keep this risk constant, regardless of what the market is doing.
IFA's funds have done very well over the past decade, despite the S&P 500 having been down over the period. Because IFA prepared its clients for the market volatility, they did not freak out and sell everything at the bottom.