What to do when the market goes down?
First of all; don’t worry too much: ups and downs in a portfolio are normal. While it may be unnerving to log in and see your retirement accounts take a hit, investing is for the long term, and you will regain that value. Don’t let your emotions rule your portfolio at a time like, and follow these steps:
Don’t sell unless you absolutely have to
Our instinct as risk-averse, mathematics-hating humans is to sell when things look bad. When our portfolio is dropping, we want to save ourselves from losing even more, even though this may be the worst thing to do. Keep a level head and don’t trade on emotion. Your retirement accounts are a long term investment, so try to ignore the short term volatility (as hard as this can be) and focus on the long term. If you have [link] an emergency fund and your basic needs covered, avoid selling stocks.
Dollar cost average
Counter-intuitively, a down market is the best time to buy – think of it as a stock sale. If a company has good financials (and this is key), it will still be around when the market returns to normal, and you will have acquired it at a discount. Obviously it is always a possibility that some companies will go out of business, such as Circuit City and many others during the great recession. However, if you have a well balanced portfolio, that includes ETFs, you are holding a basket of stocks that represent the larger market, and you will be less effected by a bankruptcy of an individual company in the mix.
Don’t try to time the market.
Remember, it’s incredibly difficult (basically impossible) for a retail investor to time the market. Be skeptical about most technical analysis strategies; It’s easy to find a market timing claim that backtests well (eg. “Sell x when it’s current price dips below y% of its z day moving average), but the problem with these so called strategies is that they are extremely susceptible to hindsight bias. In other words, hindsight is 20/20! Even if you can look back and find a technical analysis strategy that would have worked, there is no guarantee that part results are indicative of future returns. For a great discussion on this, check out A Random Walk Down Wall St.
So don’t try to wait for the absolute bottom, or you could miss out on gains from an uptick. Similarly, don’t try to sell at the top. Instead, Dollar Cost Average. This is when you buy stocks at regular intervals and with a set amount if money – for example, a specific dollar amount monthly or a percentage of every paycheck.
Simplified example: you plan to put $500 a month into an ETF. This month, it costs $50, so you buy 10 shares. Next month, it’s down to $4. You’re a little nervous because of the decline, but you stick to your $500/month plan and buy 125 shares. Not only does this take some of the emotion out of investing, it has the added benefit of ensuring that you buy more shares when they are cheaper and fewer when they are overvalued.
Think about your asset allocation
If you are young and years away from retirement, a decline in the market shouldn’t bother you. It will bounce back, and you can look at this as an opportunity to pick up more stocks while they’re on sale. If you’re getting closer to retirement age, make sure you have bonds in your portfolio to add stability, since you have less time to wait for the market to regain value. A general rule of thumb is that your age should be the percentage of your total bond holdings, although this is subject to personal preference and risk tolerance. If you invest in a Target Date retirement fund you have even less to worry about, as these accounts automatically weight your allocation towards less risky investments as you near retirement age.
So, keep your head up and happy investing.
The Millionaire Next Door: The Surprising Secrets of America's Wealthy
by Thomas J. Stanley and William D. Danko
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Eleventh Edition)
by Burton G. Malkiel
The Intelligent Investor: The Definitive Book on Value Investing
by Benjamin Graham and Jason Zweig
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Please note that this is general financial advice that is applicable to most people, but it is not a substitute for consulting with a professional financial adviser. Your mileage may vary.