In August this year, the market dropped more than 6%. Lately, the market hasn’t been so hot either. When the market tanks, it can be a hard pill to swallow for any investor. That much, you already know. The question is, what should you do about it?
In my experience, there are 3 steps you should take in order to not make a bad situation worse. Let’s dive in:
1. Don’t Panic
I’m not saying you should just sit there and take it. We’ll get to that in a minute. But the first most important thing to do is to stay calm. I know this is easy to say and hard to do.
But the fact is that few people make good decisions under stress. In order to make sure you don’t over or under react, calm yourself first. You’ll hear plenty of traders and talking heads tell you to jump on this or jump out of that and it will sound like good advice. But do yourself a favor and ignore them for the moment. Again, you may indeed need to make some changes, but you’ll be doing yourself a solid if you proceed calmly
2. Get Perspective
In order to decide where to go, you have to first know where you stand – and that means you need perspective. Let me explain exactly what I mean.
In August the market dropped more than 6%. But did you know that for the year the market was down less than 4% as of 8/31/15? Don’t get me wrong – losing 4% is nothing to throw a party about. But when you look at the situation this way, it paints an entirely different story. When you lose 6% in a month your mind does the math. Your head extrapolates this loss over the next 12 months and tells you that you’re going to lose 72% of your money if this bad situation continues for another 11 months (6% loss for 12 months is 72)! Aye Carumba!
The thing is, there is no way of knowing how long this bad situation will last and there is no way of knowing when it will turn and go back the other way. It is hard to digest big losses in a very short period of time – that’s why it’s so important to look at this in perspective. This tip is especially important if you are retired and desperately interested in safeguarding your retirement income. If you consider that you are probably down about 4% for the year and that most of the preceding years have been pretty positive, you might feel differently about your current situation.
Red ink makes you anxious – I get it. But intellectually you already know that negative returns are inevitable. In fact, according to JP Morgan, the market often has a ugly periods during the best of years (the average dip is about 7% during a year – and this includes years when the market ends up in positive territory.) In other words, even under the best markets, investors have to learn to live with losses during the year – in not many years.
Try to tune out the noise. Don’t look at your account values every day and don’t watch or listen to the fear-mongers either. Get a balanced reading on what’s going on in the markets and economy instead.
3. Make Appropriate Changes
Sometimes doing nothing is the right thing to do. And in situations such as they are right now, that can take a lot of work. Why? Because staying the course sometimes goes against every impulse in your body which is craving for safety.
This is not to say that doing nothing is the right thing to do. It might be, but it also might not be. Review your overall investment strategy. If you work with an advisor – talk to them and review it together. If your investment approach has worked for you in good and bad times in the past, you probably should consider sticking to it. And if that calls for holding on, that’s probably the way to go.
On the other hand, if your investment strategy is more dynamic and calls for making changes to your holdings as the market shifts, you should stick to those rules (assuming you’ve been satisfied with those results in the past) and take the action your strategy calls for.
If this doesn’t satisfy you, consider downshifting your risk. Consider moving to a balanced portfolio – something with less exposure to equity. Doing that can give you more sleep at night and it could possibly still allow you to reach your financial goals.
Just make sure that you revisit your financial plan before making any huge changes. It might feel good right now to get in from out of the cold that equity exposes you to, but over the long-run becoming super conservative during market corrections may dent your overall long-term portfolio results. You can’t have your cake and eat it too Pilgrim. If you reduce risk, you have to be ready for lower returns over the long-run.
What About Reducing Risk Only When The Market Is Bad?
There are investment strategies that try to do this and some do a pretty good job of it – at times. But every market approach has its pros and cons and nothing works perfectly. What I’m trying to say is that investors have to pick their poison. If you have an investment strategy that tries to time the market, that’s OK. You should have a rule book that tells you when to make your moves based on objective data rather than gut emotion and you should stick to those rules.
If you don’t use such a strategy you might consider this approach – but don’t do so out of fear. As I said, every investment method has its day – and its dog day afternoon. The last thing you want to do is to jump from the fire into the frying pan.
Market downturns are scary and they don’t feel good. I wish there were a way to avoid these situations but there really isn’t other than avoiding investing in the market all together. If you do that, you may be able to sit out huge hits to your portfolio. But you may also jeopardize your ability to achieve your most important financial goals. That could end up costing you a lot more.
What are you doing as a result of this choppy market?