Last Thursday, August 17th, 2017, the S&P 500 logged it’s second largest one-day decline of the year, at 1.54%. In the scheme of history, this is not particularly newsworthy. After all, the S&P 500 has logged much larger percentage losses in the past, as the table below shows.
If you are a long-term investor, you shouldn’t be tracking the markets daily. However, if you happened to track your investments that day, and you have a substantial sum invested in the markets, you probably noticed that your net worth decreased by thousands of dollars in a single day. When this happens, don’t panic. Instead, here’s what you should do when the markets go down, as they will many, many times over your investing career.
1. Put it in Context
Understand that a single-day drop means very little in the scheme of time. For example, despite the 1.5% drop last Thursday, the S&P 500 is still up 8.3% for the year.
2. Don’t Sell
When the markets go down, your losses are simply paper losses. You haven’t actually lost any money until you sell at a loss. So hang in there and ride out the mud.
3. Buy More
If you are witnessing a sizeable drop in the market, on the order of 5-20% or more, think of this as a sale. This is not the time to be fearful. This is the time to put your paycheck to work and buy more. It can be frightening to continue to invest into something that continues to drop, but you will win in the long run.
4. Understand that the markets will eventually go back up
The stock market goes up and down, but eventually it always goes up. If it didn’t eventually go up, no one would invest in business, the economy would tank, and our financial system would collapse. When the next bear market arrives, keep the following chart in mind. The average duration of a bear market is around 1 year and for every bear market, there is always an aggressive bear market around the corner.
If you are many years away from “retirement” and won’t need the funds in your investment accounts for a decade or more, then it is relatively easy to ride out a bear market using the strategy above. However, if you are nearing retirement and might need access to your money within 5 years, then a strong, prolonged bear market could devastate your portfolio.
Therefore, as you approach retirement, I recommend you gradually increase the percentage of bonds in your portfolio to reduce volatility and potential losses. I also recommend you have a large cash cushion in your portfolio to avoid selling at a loss. There will be more on this in future posts.
When the stock markets crashes and you envision all your hard work spewing off a cliff, remember to place the drop in context by looking at historical data. Avoid selling at a loss, and if you have the fortitude, think of the drop as a sale and buy more shares. Hang in there and understand that the markets will eventually recover.