When the stock, crypto, or even real estate market experiences a downturn, many investors may panic and feel tempted to sell their investments. However, doing so is likely not the best course of action. While it can be uncomfortable to see the value of your investments decrease, remember that stock market fluctuations are normal and are to be expected. Remember that panic selling can often do more harm than good.
Why It’s Important to Stay Disciplined When the Stock Market is Falling
A stock market correction is a natural and expected part of investing. While it can be difficult to watch the value of your portfolio decline, remember that this is normal and there is no need to panic. A stock market correction is often accompanied by feelings of panic and uncertainty, as investors worry about the potential impact on their portfolios.
Staying disciplined during a stock market downturn is crucial for ensuring that your investments continue to grow over the long-term. When you are faced with the uncertainty and volatility of a falling stock market, it can be tempting to sell off your investments to avoid further losses. However, doing so will only serve to limit your potential gains and potentially impair the growth of your portfolio in the long run.
The effects of panic selling during a market downturn
Here’s some math to think about: When your portfolio is down 20%, it must recover by 25% to get back to the same level it was. When the portfolio is down 30%, it must recover by 42% to get even. This math just gets worse the more the market goes down. If you sell your portfolio when it is down, you will then have to find new investments that deliver a dramatically higher return to just get even – it’s not an easy task! And more likely than not, after panic selling during a downturn, most investors tend to miss out on the rally, so trying to get a 42% after the market rebounds is going to be almost impossible.
Don’t Miss the Best Days in the Market
According to a study by the Bank of America on the S&P 500’s returns, if you sat out the S&P 500’s 10 best days in each decade, your returns would be significantly lower than what is possible when waiting it out. Unsurprisingly, the best days also follows days with large drops, which means that you have to be invested to get the benefit of those days.
The numbers really paint an excellent picture here:
- If you stayed invested from 1930 to 2020, your total returns would have been 17,715%, which means that if you invested $1,000 in the S&P 500 in 1930, you would have ended 2020 with $178,150.
- If you were unfortunate enough to miss the 10 best days in each decade, which is really only 100 days out of a total 36,500 days (0.3% of the days), you would have ended up with only $1,280!
- On the flip side, if you were somehow magically invested on only those 100 best days in the last 100 years, you would have $37,938,870!
The moral of the story is that if you believe you have reasonable stocks and bonds in your portfolio, you’re much better off just hanging on and not selling anything. It might feel bad now, but you’ll feel much worse later when you realize what you have missed out on when the market rallies.
Can You Believe that Stocks Are More Stable in the Long Run?
To truly reap the benefits of stock market investing, it is essential that you stay focused on your long-term goals and resist the urge to take rash action when markets decline. According to a study by Jeremy Siegel and Richard Thaler, the annual standard deviation (commonly called volatility) of US stock returns between 1801 and 1995 is 18.15%, vs. 6.14% for T-Bills.
However, over 20-year intervals, the standard deviation of US stock returns is actually lower than T-Bills: 2.76% vs. 2.86%. This is despite stocks returning 10.1% CAGR compared with 3.7% for T-Bills.
What does this mean? It means that in any short interval of time, stocks are more volatile than bonds. This is not a surprise, of course. However over much longer periods of time, stocks are actually less volatile and deliver higher returns! Can you believe that?
What does this mean for you specifically? It means that if you are invested in the stock market, your stock portfolio will be more volatile on a day-to-day and year-to-year basis. However if you stay invested for the long run, the data shows that over the long-term your portfolio will actually be much less volatile than bonds!
Therefore by staying disciplined and patient during times of uncertainty, and staying focused on your long-term goals, you can weather any short-term dips in value and emerge stronger than ever before. So, if you’re feeling tempted to sell off your stock market investments during a market correction, take a deep breath and remember that panic selling is not the solution.
Tips for Staying Calm and Rational in Times of Market Turmoil
Here are a few tips for staying calm and rational during times of stock market turbulence:
- First and foremost, remember that stock market corrections are normal and should be expected from time to time. There’s no need to panic when the market takes a dip. Instead, try to stay calm and focus on your long-term investment strategy. Use whatever methods and tools you have at your disposal to help control your emotions: exercise, meditation, walks in the park or at the beach, sharing your feelings with a friend or spouse. This stage is about controlling your worst instincts.
- Secondly, keep perspective: Remember that stock market declines are a normal part of investing, and they don’t necessarily reflect the underlying value of your investments. Try to stay focused on your long-term financial goals and resist the urge to sell. Remember that better times will come eventually.
- Resist the urge to sell off your investments prematurely. While it’s natural to be tempted to sell off your stock holdings at a loss, this is usually not the best move. By keeping a level head and maintaining your long-term perspective, you can weather market downturns without sacrificing your investment goals.
- Finally, remember that stock market corrections often present opportunities for savvy investors. Rather than rushing to sell, try taking a proactive approach by looking for good buying opportunities during times of market turmoil. Some of the best investment opportunities are available during a crash. With some strategic planning and careful management, you can emerge even stronger from stock market turbulence than before.
But I need the cash..!
What do you do if you really need the cash though? It is possible that you absolutely need the cash and the timing of the crash is wrong. Your plumbing just sprung a major leak and you might need a big chunk of cash to fix it. Life happens!
Or it could be that you unfortunately bought stocks at too high a price or with too much hype. What do you do then? The standard advice is of course to not sell and hang on for the ride with all you’ve got! But not all stocks recover equally from a market correction. It is called a correction for a reason, right?
The standard advice is to remain calm and not sell. However, it is important to realise that sometimes, selectively selling some components of your portfolio may be the only right decision. If you end up in a situation where your back is against the wall and you have to sell as you actually do need the cash, the best action is to speak with a licensed financial adviser and seek their professional opinion. They hopefully will be able to guide you and help you navigate the selling decision by trying to minimize the long-term damage to your portfolio. Remember at this stage, you are just trying to make the best out of a bad situation.
Tips for When Better Times Return
It is important to keep in perspective that every stock market correction is accompanied by a corresponding move upwards. If there was no move upwards, the market would have reached 0 many times by now. But even through two world wars (one involving nuclear bombs), big regional wars, global pandemics, multiple global depressions, economic and political scandals, near collapse of the financial system, Brexit, Grexit, etc., the market has never gone to 0.
With that in mind, here are some tips to remember when the market recovers and you are in a better emotional state:
- Remember the feeling when the market was down: Did you panic? Were you unaffected? Or were you excited by the opportunity? These feelings and your reactions to them help determine your risk tolerance to market volatility. Talk to your financial adviser or if you are DIY investor, have a talk with yourself! Ensure that your portfolio is aligned with your risk tolerance and financial capacity. If you need to make changes, this is the time to do it (not when you are down).
- Do your financial objectives align with your portfolio? When invested in a responsible manner, the stock market is a great way to preserve and grow wealth over the long term, which means over a time horizon beyond 5 to 7 years. Talk to your adviser and establish the correct asset allocation. If you need money to buy a house, or for your wedding, or for your retirement within a period of 3 years, you may want to dial up the cash savings component of your portfolio. The time do it is when the market is relatively calm, not when your portfolio is down 25%.
- Avoid leverage (i.e. debt or loans) to invest: The stock market is brutally efficient at wiping out your net worth when you use uncontrolled leverage. Even the supposedly best investors in the world have gotten into trouble when they were leveraged up too high. Whether you are a pro or a novice, remember that no matter how much your portfolio has crashed, your debt will still be due in its full amount. Banks and brokers will place margin calls and force sell your portfolio faster than you can say Oops!
- Do not buy bad stocks or other items hyped-up prices: While this topic could easily be a multi-day lecture series, it is important to remember to not buy stocks in companies that sell dreams of the future and trade at multi-billion dollar/pound valuations. It is the fad stocks and other items of dubious value (NFTs?) that lose value the fastest in a market correction. The odds are high that these stocks/products/fads will not recover in the upturn. Good companies with sound business models and healthy financials are the ones that will recover and go on to thrive. This is the economic cycle in action. The best protection against a down market is achieved during an up-market. You buy insurance before something bad happens, not after! A good option to consider would be buying broad market ETFs instead of single stocks as that helps to diversify your portfolio and mitigate risk from single companies.
A market correction brings out the worst feelings in people – panic, anger, sadness, uncertainty, etc. If you are feeling any of these emotions, then it is important to first get control of your emotions. When the stock market is falling, it’s important to stay disciplined and resist the urge to sell off your investments. While it can be tempting to panic in times of market turmoil, this is usually not the best move. By staying calm and focused on your long-term goals, you can weather any stock market declines without sacrificing your financial objectives.
Ultimately, the best way to deal with a stock market decline is to maintain a long-term perspective. Try to remember that stock market corrections are a normal part of investing, and they don’t necessarily reflect the underlying value of your investments. By staying disciplined and keeping your eye on the big picture, you can navigate any stock market turbulence without losing sight of your ultimate financial goals.
What to do if Wealthsimple is losing money?
Don’t do anything. Wealthsimple is a professionally managed organization with an investment strategy that relies on using ETFs. If your Wealthsimple account is going down because of a broader market correction, then your best bet is to do nothing. Do not panic sell. The market will eventually recover over time and your investments will recover along with the market.
What to do if Nutmeg is losing money?
Don’t do anything. Nutmeg is a professionally managed organization with an investment strategy that relies on using professionally managed ETFs and funds. If your Nutmeg account is going down because of a broader market correction, then your best bet is to do nothing. Do not panic sell. The market will eventually recover over time and your investments will recover along with the market.