Step #7 Think correctly about market fluctuations
If you’re a retired US expat, a rising market should make you happy. You’re likely withdrawing from your investment account, and a rising market assures that you won’t deplete your resources. But if you’re going to be working, and putting money into the markets for at least the next five years, you need to hope for lower market levels (Lawrence A. Cunningham, The Essays of Warren Buffett: Lessons for Investors and Managers, Singapore: John Wiley & Sons (Asia), 2002, p. 71). Warren Buffett says that many investors don’t think correctly about market prices: “Only those who will be sellers of equities [stock market investments] in the near future should be happy at seeing stocks rise” (Cunningham, 2002, p. 71).
Think of the stock market the same way you think about buying groceries. In a dozen years, you can be certain that you’ll pay more for your groceries. The same premise should hold true for the stock market as well. So if your supermarket has a sale on non-perishable groceries, don’t you want to load up on the discounted products? Of course you do. But, using the supermarket as an analogy for the stock market, too many people shun the supermarket when its products are on sale, and they rejoice when they can pay higher prices for their groceries.
The sooner you embrace the concept that cheaper prices are good for purchasers, the better. Most investors sabotage their investment results when they react to what the markets are doing.
For example, let’s assume that your neighbor (who’s a lawyer, not a US expat) bought a mutual fund called “ABC Fund”. He added money periodically to ABC Fund for 10 years. And let’s assume that this fund made 10% per year, as an average, over 10 years. You’d think that your neighbor would have annualized 10% on his money, right? But if he accurately represents the average person, he wouldn’t have made this return. His returns would have been nearly 3% below that 10% return, based on John Bogle’s 25-year study (John Bogle, The Little Book of Common Sense Investing, 2007, p. 51).
I’ve already demonstrated how damaging a 3% lag can be over time. But why doesn’t this guy end up making 10% if his mutual fund (or index fund) made 10%?
In essence, when the markets are rising, the average person puts more money into their stock market funds. And when the markets are falling, they cease to buy, or reduce their purchases. This is the opposite of what investors need to do. The old maxim, “Buy low, sell high” is actually practiced in reverse by most people.
If you deposited equal amounts into your funds, religiously, each and every month, you’d surely generate returns that would equal the reported fund returns—as long as you weren’t paying sales fees. And if you’re disciplined enough to “be greedy when others are fearful and fearful when others are greedy”, as Warren Buffett suggests, you can even outperform the funds that you’re investing in by buying more aggressively when the markets are getting hammered. To read more about Buffett’s philosophy online, you can check this story on the CNN Money website, or read Lawrence Cunningham’s The Essays of Warren Buffett.
This post was originally the chapter “The International Teacher’s Nine Steps to Financial Freedom” in the book Reviving, Retooling and Retiring for Teachers (published by Michigan State University). It was graciously reposted here by Andrew Hallam, public speaker, author of Millionaire Expat: How To Build Wealth Living Overseas, and webmaster of andrewhallam.com where this post also appears. The word “teacher” was sometimes replaced with “US expat.”