Stock Market Crash: Your 10 Big Questions...Answered

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Includes: DIA, QQQ, SPY
by: Vishal Khandelwal

Crash. Collapse. Carnage. Calamity. Meltdown. Panic.

Well, these are some attention-grabbing keywords you must have heard and read in business media over the past two days. Even I used the word crash in the headline of this post to grab your attention. And it worked, didn't it?

Well, that's the way the psychology of fear works, and especially when it come to the stock market. The media adds so much fuel to fire, that short-term losses end up overshadowing our awareness about the possibility of long-term gains.

Amidst this, here are answers to the ten key questions on the current crash I have received from tribe members since yesterday - all asking what to do as others around them lose their heads.

You won't find perfect answers below, but this is just my attempt to help you get over your fears, which may otherwise lead you to act in haste, which can cause some damage to your process of long term wealth creation.

Let's start right here.

1. Why is the stock market crashing?
I am no stock market expert who would enchant you with his/her accurate post-market reasonings and predictions. All I know, in simple words, is that a lot of people in China are worried that their stock market and economy are finally in a bubble, and are thus selling stocks under fear that the bubble may burst soon.

While the Chinese government and central bank (who allowed the bubble to grow in the first place) are already acting to control the wildfire, they seem to be falling short against the rampaging herd of stock market sellers.

Talking about herds, well this is how the stock market behaves in the short term, under the influence of people all moving in the same direction. And large number of stock investors (or, let's call them 'speculators') in India - both domestic and foreigners - have decided to join the Chinese herds in selling their stocks, especially those bought on margin or borrowed money. And that is causing the crash.

2. Is it like 2008 again?
Whether this situation is like 2008 is impossible to predict, especially for me. You may be hearing some predictions on business television, but then as I mentioned, predicting is futile and I am not an expert in it.

All I can say is whether this turns out to be like 2008 or not is unknown. But it seems that things could remain difficult for some time to come…and can get more difficult if you continue to watch and read those headlines in business media that has a habit of taking things out of proportions.

So, if you wish to curtail your worries, first please stop watching/reading such media. That will give you ample time and sense to think calmly and wisely through this situation.

After the latest decline, stocks are a little cheaper than they were before it all began. But they could get a lot cheaper still before this is over.

Also note one thing. This is not the first time that events like this are happening. We have seen crashes and economic calamities of bigger magnitudes several times in the past. Remember the Asian crisis of late 1990s, dotcom crash of early 2000s and the subsequent global economic slowdown, the 2008 crash and the subsequent economic meltdown, etc. Not to forget that the developed world continues to sit on currency and credit bubbles of huge proportions, and that the central banks there are just postponing when the bubbles hit the pins.

But you cannot predict if and when that happens and remain on the sidelines holding the end-of-the-world banner. And, by the way, some things solve over time, and life returns to normal. Sometime it takes a lot of time, and patience is severely tested, but these are the times that make you tough and create the base of a successful investment track record. You should be the last man standing when the Sensex touches 15,000…and still optimistic and investing for the future. I'll be there with you (even Anshul has promised me that).

3. That sounds good, but should I do something about this crash?
Let me ask a counter question - Is this really a crash? Honestly, at this point it's very difficult to answer. It might turn out that the panic was just because of people's 'denominator blindness', which is the tendency to focus on absolute number i.e., getting worried that Sensex crashed 2,000 points in very quick time - 28,000 to 26,000. This, in absolute terms sounds big, but it's hardly a 7% change. A 7% decline in your stock in 2-3 days doesn't sound huge, right? So why are you worried about a 7% decline in the Sensex and call it a 'calamity'?

Please understand that the stock market moves in cycles, and thus fluctuations are inevitable. The market has experienced a slight but quick drop in prices, which seems to be worrying you. But it is a part of the cycle.

Calm and sensible investors usually see opportunities in market fluctuations. They buy when the prices dip below business values and sell when the prices rise. As Warren Buffet says, investors should be able to look at market fluctuations as their friend rather than an enemy. You should profit from folly rather than participate in it.

By the way, Subra has a nice advice up on his blog [1] -

If you are sure of your job (cash flows) for the next 5 years, you have a monthly surplus, your goals are far away continue your SIP. If you have say Rs. 100 SPARE to top up your sip, do not be in a hurry. Top up Rs. 30, and keep Rs. 70 in liquid funds. If the market were to say go to 23000 you will have a chance to invest another 30…and then 21000 invest your remaining Rs. 40.

Then, start with a prayer. It helps.

4. Can't help…I am still worried! Should I sell and cash out before market falls further?
Well, if you are becoming agitated with a single digit percentage correction in markets, then you must be worried. In fact, you must seriously reconsider your decision to be in direct equities.

If you haven't figured out your temperament, the stock market is a very expensive place to find out. A long term view requires an ability to stomach extreme short term market volatility. If you can't do that, you may want to move your money to other instruments like bank fixed deposits and liquid/debt funds.

As Jason Zweig wrote in his recent post on WSJ [2] -

In order to capture the potentially higher returns that stocks can offer, you have to reconcile yourself to the certainty of horrifying short-term losses. If you can't do that, you shouldn't be in stocks-and shouldn't feel any shame about it, either.

5. Is this an opportunity to buy more stocks?
If you have identified businesses that have great potential, according to your analysis, to be wealth compounders, then yes! These crashes will look like tiny blips over a 10-year period. Don't interrupt the compounding unless there is a question about the quality of the compounding machine.

But here is a caveat - If you think this a time to be greedy because everybody seems to be panicking, then ask yourself whether your greed is driven by your confidence in rational analysis of the business, or is it actually a manifestation of an underlying fear, the fear of missing out? Is this really an opportunity or just a distraction?

Don't forget, short term market fluctuations (even the significant ones similar to what's happening now) are severe distractions for our awareness about long term gains.

The few questions you must ask yourself are:

  • Would this crisis impact long term cash flows of the businesses I own?
  • Would this crisis impact the very foundations of these businesses?
  • Have I invested using borrowed money?
  • Have I invested in stocks based on tips, as I know nothing about the underlying businesses?
  • Would I need the money I've invested in stocks over the next 1-3 years?

If the answer to all the above questions is 'no', then there is no reason for your to panic. Sit back and relax.

6. So what should I do? I want a final answer.
When you have no move, my friend, you do not move. You do nothing! Sit tight, and read a good book.

On the other hand, if you have a well-thought out move on how to deal with this situation, then move! But first, please move and switch off that business channel. Don't let the experts' running commentary fool you into thinking that they can help you identify (especially using charts) some exact entry point at which you can know you're buying back into stocks at a bargain level. The future is uncertain, and no chart or predication can add any certainty to it.

In all, act wisely and never accept anything at face value. And do not indulge in spreading the market crash panic and rumours further. As the Jewish proverb goes - "What you don't see with your eyes, don't witness with your mouth."

7. All this sounds soothing, but I remain unnerved. What do you suggest I should do?
As I said, don't worry and don't act in haste.

And please remember, as always, this too shall pass!

8. By the way, my portfolio advisor just gave me some good news. I made a profit of 40% last year, and now my portfolio is down 30%…so I am still net-net 10% in profit. That's comforting, isn't it?
Ooh la la! Rs 100 growing to Rs 140 and then falling by 30% doesn't become Rs 110. It becomes, hold your breath, Rs 98. So, I'm sorry, but you are -2% down. By the way, who's your advisor, and how did he manage a 30% decline when the market is down less than 10%?

9. Oh my God! Well, let me finally confess something. I recently doubled down on stocks and bought a lot based on my advisor's and friend's advice. They recommended some high "moat" businesses, though I don't understand what that means. Anyways, now these stocks are substantially lower in prices now. What should I do of them?
Please take my advice here. Sell all your stocks, even if in a loss, and move completely out of the stock market. It is not a place for you. Come back only when you are wiser about your investments, know where you are putting your money, and are willing to do your own homework before investing your hard-earned money.

Remember what George Goodman aka Adam Smith once said - "If you don't know who you are, [stock market] is an expensive place to find out."

I want to leave you with this tweet I posted earlier today, in case you understand Hindi…

Moat Kii Deewar #investing #moats pic.twitter.com/7bQE3iR9al

- Vishal Khandelwal (@safalniveshak) August 25, 2015

10. Tell me what stocks you are buying?
Short answer - Please spare me!

Long answer - See I told you, the stock market is not a place for you. You will ask for my tips, and God forbid, I give you some, you will blindly invest in them. Then, when those stocks fall and you lose money, you will abuse me and tell me what a fool I am.

So, let me tell you upfront that I am a fool with no good stock tips to offer. Plus, I have been wrong many times in the past. As Jesse Livermore is supposed to have said [3] -

Tips! How people want tips! They crave not only to get them but to give them. There is greed involved, and vanity. It is very amusing, at times, to watch really intelligent people fish for them. And the tip-giver need not hesitate about the quality, for the tip-seeker is not really after good tips, but after any tip. If it makes good, fine! If it doesn't, better luck with the next.

It has always seemed to me the height of damfoolishness to trade on tips.

Tips are just that. Tips. Following blindly is setting you up for epic ruin. First of all you have no idea what position that tipper is in. He may not even hold the stock he is recommending. Even if he is, you have no idea when he will unload his lot. Suppose he is selling his stock to you. Then you would be forced to dump it to someone else for a higher price.

Got it? No? So again, please spare me!

By the way, if you are still stuck and worried, and have any further question to ask me on the crash, except stock tips, please shoot in the Comments section of this post.

Notes

[1] Market Fell 1,624 Points. What To Do?
[2] The Cruel Psychology of the 1,000-Point Drop
[3] 3 Big Investing Lessons from the World's Greatest Stock Speculator