It’s sometimes hard to remember that you have a plan when the stock market is dropping, but here are a few things to consider before you decide to begin selling your stocks while the market is down. It’s better for the portfolio to avoid selling in a drop, since you might be selling at a loss.
Is the drop is within market norms? Stock prices do not increase in a straight line forever: they rise, then they fall a bit, then rise again, and then fall again… over and over. In general, the stock market experiences a 10% drop about every twelve to eighteen months or so. This is an expected feature of the market; it’s not a catastrophe, but rather how the market functions. It might even be a good entry point for buying in, for an investor with cash on the sidelines.
For most people, their day-to-day expenses are not coming from the stock portfolio. Individual investors should have a prudent cash reserve, and depending on the situation, perhaps some bonds that don’t fluctuate with stocks. If you don’t need to withdraw money from a dropping stock position, you can wait it out and then hang on for the recovery. Because of these stock dips (which investors need to withstand to capture the gains when stocks are rising), stocks are appropriate for long-term goals such as retirement. Bonds can provide a cushion against the volatility for medium-term time horizons, to earn a bit more money than cash, which is fine for short-term expenses.
It’s natural to want to sell when the stock market is declining, because our brains want to avoid pain. Unfortunately, this natural instinct is terrible for the portfolio, as it leads to selling low and locking in portfolio losses. By contrast, an investor who can stay with their investments will not only avoid selling at a loss, but will also participate in the recovery as asset prices rise from the bottom.
If only it was possible to know ahead of time when stocks would fall and when they would gain! Regrettably, it isn’t, which means it’s generally an exercise in futility to attempt to buy and sell at the correct times. Much easier to develop a portfolio to stick to, no matter what the market is doing. We’re in 2018 with the second longest recorded bull run in US history still continuing. (A bull market is one where prices rise without dropping 20%.) Pundits have been calling for the bull to end for the past several years, and yet, it keeps running. It will end eventually, we just don’t know when. Anyone who was nervous about the age of the bull or worried about some of the events that have occurred in the past few years and pulled their money out of the market, has missed out on those gains.
In addition, it will most likely be helpful to turn off the financial news. The goal of the news (of any kind) is to make money, and for this it’s easy for news organizations to use emotions like fear and greed. The trend over time is for the market to increase 6-8%, but that doesn’t happen every month or every year. If you watch the financial news or look at your portfolio on a frequent basis, you will see or hear the noise of the markets going up and down, which disguises the overall growth trend. It’s much easier to stick to the plan when you’re not distracted by all the noise.
In times of market turmoil, it’s often helpful to remember: This too shall pass.