When the media machine is pushing the panic button during a stock market decline and you see headlines like, “record setting market losses” or “the market crashes,” keep in mind a few “do” and “don’t” tips.
Continue to invest- It is a mistake to stop investing because you see your account going down. If you think you are losing money, and throwing more at it would be a waste, think again. By investing while the market is down you are actually doing what savvy investors want to do, buy low. Of course, by investing when markets are selling off, you are not guaranteeing that you will make money in the short term. However, if you were planning on investing a sum of money, when would you rather do it? When the market is high or when the market is low?
Dollar cost average- If you are investing via a 401K or similar employer plan, you are already dollar cost averaging. Simply put, adding money on a weekly or biweekly basis, you are buying into your investment at different prices that over a period of time average out. In other words, the market will be up and sometimes it will be down the day your investment goes in, but over a period of time, you average your buy in price. This can help take the guess work out of investing on the best day or the worst day. For example, if you were planning on investing $10,000 over the course of the year and you had hindsight, you would want to invest your money when the investment was at its lowest point of the year. Conversely, you would not want to invest at the highest point of the year if given a choice. In the real world investors do not have the luxury of hindsight, so what do you do? The answer: dollar cost average. Invest a portion every week, two weeks, or month, depending on your employer plan. This way you will have some periods when you are buying low and some periods when you are buying high, but the price will end up averaging out somewhere in between. While this strategy will not guarantee profits, it does take some of the guess work out of investing. This strategy can also be used outside of employer plans with almost any investment.
Diversify- For most investors, having all of your money in one asset class, such as large company US stocks, generally doesn’t make sense. If you have all of your money in the same asset class and that one asset class goes down, your entire portfolio will suffer. On the other hand, if you have a well diversified portfolio with different asset classes in multiple sectors, it is not likely that all holdings will go down or up at the same time. While diversification is not a guarantee of success, the old saying “don’t put all your eggs in one basket” applies. If one basket drops, your entire collection isn’t lost. The same holds true in a well diversified portfolio. If one asset class, such as large company domestic stocks, drops, other asset classes may go up or not drop as much.
Don’t panic- It seems as though every time the market drops more than a couple of percent, the media goes crazy with the ‘sky is falling’ stories and articles. This hysteria seems to feed the selling and drives the markets even lower. Don’t feed into this type of selling. Selling based on emotions, in this case fear, generally does not benefit you. Take a moment to consider that the stock market, as measured by the S&P 500, has come back from losses 100 percent of the time since its creation. While past performance is not a guarantee of future returns, the reality is that over time the markets have rebounded. The major unknown is how much time does it take for the markets to come back. There are periods when it has taken only weeks or months and other times it has taken years. That isn’t to say that some individual companies didn’t go out of business or that all investments in the stock market were profitable. However, when the overall economy has recovered, usually so has the stock market.
Don’t sell- Unless you really need the money, do not sell while the market is in a free fall. This panic type selling generally doesn’t pay. If you sell while your investment is down, you truly lock in the loss, whereas if you wait it out, the loss you see on your statement is only on paper. In other words, if you have good sound investments prior to the market downturn, why are your investments not good during and after the market volatility? Never sell out of fear or panic as it generally doesn’t pay.
Don’t time the market- If you think that you should pull your money out of the market due to perceived or actual stock market declines, when do you put it back in the market? The simple answer is, when the market is at its lowest. Easy to say, almost impossible to do. Considering that in 2007 to early 2009, the S&P 500 lost almost 50% of its value. This was unnerving and shocking to any investor and outside of normal corrections. Someone who could time the markets perfectly would have taken their money out October 8th and added the money back on March 7th 2009. That kind of timing is like winning the lottery and nearly impossible. People who panicked and took their money out of the market during the financial crisis, may not have added it back when the markets looked so bleak. If they didn’t add money back until 2011, not only did they miss out on over 35% gains in the value of the S&P 500 but they also added back during a nearly flat year in the markets. In other words, hindsight is 20/20 and it is easy to pick the best times to buy or sell looking back, but for most investors, time in the market is far better than trying to time the market.
In times of market turmoil, it is important to remember that actions taken in haste or out of fear generally do not benefit the investor in the long run. A more prudent and thoughtful approach that takes into consideration risk tolerance, time horizon, and goals makes more sense for most investors.