When stocks start to go down, it can cause a lot of anxiety and unpredictability with your finances. It isn’t easy to know what to do when stocks go down. The U.S. stock market is down by more than 13% in 2022. Investors are anxious about high inflation, the war in Ukraine, and the COVID lockdown in China. Should you be worried?
Sam, one of our clients, called me the other day. He is typically calm, rational and not afraid of opportunities. But he sounded tense. He just saw his accounts drop in value in the thousands. He urged me to sell everything to cash and wait until the market stabilizes. Is this the right course of action?
Fight or Flight Response
When we perceive danger, the region of our brain called amygdala gets activated. We experience fear and we want to make a run for it. So Sam’s reaction is normal. But what if the perceived threat is not really a threat?
The good thing is the amygdala is partnered with another region in our brain called the prefrontal cortex. It is responsible for rational decision making. So let’s activate our prefrontal cortex by looking at the data on stock market downturns.
What Goes Down Must Continue To Go Down?
As humans, we tend to see patterns in everything. We see faces on Mars and in the clouds, and believe in a hot hand in basketball.
We typically project into the future, the trend we are currently seeing. This is a behavioral bias called Trend-Chasing Bias. When we see that the stock price of Amazon has been going up for years, we think it will likely continue to go up!
When we see the Dow Jones tumbling for the last four weeks, we think it will fall into the abyss. But will it?
What is a stock market crash?
There is no specific number that indicates a stock market crash. The stock market typically changes between -1% and 1% every day. A stock market crash is when there is a sudden and significant drop in stock prices over one day or several days/weeks/months. It may be influenced by speculative events, catastrophic events, or economic conditions.
Stock Market Crashes in History
On average, it has taken about 3.5 years for the U.S. stock market to recover, from peak to trough to peak. This is based on a study by Crandall, Pierce & Company (2018).
It could recover faster, or slower. The longest recovery I believe took about 9 years. But still, if this money is for retirement, and it is 10 or more years away, then you may be able to ride out these fluctuations.
In early 2016, a global stock market correction occurred, due to fears of a slowdown in the Chinese economy. Markets dropped by about 15%. It recovered in two months.
Most of us experienced the Great Recession of 2008. Global markets tanked by about 40%. It recovered in two years.
Why do stocks go down?
Stock market prices go up and down every day because of market forces. When a company is doing well, then people are willing to pay more to buy that stock, and the stock price goes up. If the company is doing poorer than expected, then people may be willing to sell their stock at a lower price, and the price goes down. If investors are worried about the economy, war or any bad news, stocks may go down.
What should you do with your portfolio if stocks go down?
While it can be tempting to sell when the stock market goes down, ask yourself if this is the best solution. You can consider these three tips:
1. Don’t try to time the market
Studies have revealed that if you miss the best 30 days of the market in a span of 20 years, you will not make any money in stocks. Most of the time when stocks go down, the best thing to do is to hold. One of my friends shared with me that she sold her stock holdings in late 2008, avoiding further losses. But she never invested it back in the market, thus missing the opportunity to double her money in a few years. Investing with a long term mindset can help you make more money in the long run.
2. Make sure you are diversified
Make sure your retirement portfolio is invested in a diversified manner, in a way that is appropriate to your risk tolerance. This will usually mean that your portfolio will fall only to a level you’re comfortable with. Diversification means investing in different industries, countries or different types of investments, not just different companies. The more you diversify your portfolio, the less you will lose if one of the industries or companies crashes.
3. Rebalance your portfolio
During a stock market downturn, the best course of action may be to rebalance your portfolio. This typically involves selling bonds (which normally holds in value during a crash) and buying stocks (while it is selling at a bargain). Regular rebalancing may increase your return over time.
Focus on long term investments to avoid market crash anxiety
We all worry about money. While it’s impossible to predict when the stock market will crash, you can implement the strategies we suggested to help ease some of the anxiety. If you haven’t diversified already, then start today to spread your wealth and lower the overall risk. Better yet, work with an experienced, credentialed financial planner to make sure you are being smart with your money. If you want help with your finances and are interested in having a comprehensive financial plan, feel free to schedule a discovery call with one of our financial advisors today!
Alvin Carlos, CFP®, CFA is an investment advisor and fee-only financial planner, in Washington, D.C that works with clients across the country. He has a Master’s degree in International Relations from SAIS-Johns Hopkins. Alvin is a partner of District Capital, a financial planning firm designed to help professionals in their 30s and 40s achieve their financial goals through smart investing, reducing taxes, retirement planning, and maximizing their money. Schedule a free discovery call to learn how we can help elevate your finances.
