Yahoo Finance 8 Reasons to Play It Cool When the Market Drops
The market roller coaster is back.
In exchange for higher stock market returns, investors pay a price -- market volatility. The last few years have spoiled investors with impressive stock market gains amid low volatility, but on Feb. 5, the stock market party ended with a 4.1 percent decline in the Standard & Poor's 500 index, the worst single-day point drop since August 2011. Since that plunge, stock market volatility has returned. With rising interest rates and tariffs in the news, a choppy market comes as no surprise, and more downturns inevitably lie ahead. But a rough ride is no reason to panic. In fact, here are eight reasons why it pays to play it cool during a market downturn.
Volatility is nothing new.
"Market moves are normal," says Dean Myerow, a bond portfolio manager at Las Olas Wealth Management of NatAlliance Securities. Since 2008, the S&P 500 returned an annualized 8.42 percent. Yet over those 10 years (nine of which account for the current bull market), annual total returns ranged from a decline of 36.55 percent in 2008 to a 32.15 percent gain in 2013. Morningstar recommends that investors reduce volatility with a diversified portfolio. Myerow adds this advice: "Have a rationale for why you own a particular position, and that starts with understanding why you invested in it in the first place."
Markets eventually rebound.
Investors who sell during a downturn usually lose. If you sell as the market drops, your timing needs to be right twice, when to get out and when to buy back in. "Knee-jerk overreactions to the market can potentially create an insurmountable obstacle to investor returns," says Travis Scribner, managing partner with WestPac Wealth & Wealth Strategy Partners. It's a fool's errand to overreact to market downturns. If you missed the best 30 days of trading from January 1996 through December 2015, a $10,000 investment would be worth $10,000 for zero percent growth, Scribner says. Whereas if you stayed invested during that same time, your initial $10,000 would have grown to $50,000.
Your mind can play tricks on you.
Our brains react more strongly to possible losses than to potential gains, Stanford University psychology professor Russell A. Poldrack recently wrote in Scientific American. Known as loss aversion, this behavioral bias can prompt you to sell at the wrong time, during and after a market drop. The best remedy for this is to endure the paper losses during market drops and avoid looking at investment account values in a volatile market, says Alison Norris, a certified financial planner with SoFi. There's no reason to monitor your investments daily, weekly or even monthly. A little distance from your portfolio can counteract your mind's tendency to panic over what may be just a short-term blip.
It's a great time to buy.
When you step into Nordstrom's and see the perfect dress on sale for 50 percent off, do you walk away? Of course not, you snatch up the bargain. The same rationale holds true when investing. The inevitable market crash is a sound reason to keep some cash on the sidelines as markets get frothy. After a market crash, thousands of stocks and funds are on sale, says Emmet Savage, CEO of Rubicoin. "All those stocks you wish you'd bought five or 10 years ago are suddenly available at those prices again," Savage says. Plus, "if you're investing in companies that consistently raise their dividends, your yields just went way up."
Market corrections are healthy.
When market values get too high, a market correction or return to equilibrium lets some of the air out of ballooning stock prices and keeps investors from overpaying for their investments. The current market correction is especially good because corporate sales and earnings are growing, says Colin Moore, global chief investment officer of Columbia Threadneedle Investments. When markets are fundamentally strong and consumer sentiment high, "releasing some of the exuberance is healthy for the market," Moore says.
Stocks are typically a small portion of an investor's net worth.
Most investors who own stocks also have a job, a home, bond investments, savings accounts and future Social Security benefits. Unless you need the cash that is invested in the market immediately, any decline is likely to be inconsequential to your net worth over the long term. And if you do need the money in your stock account right now or expect to need it in a few years, whether for college tuition or a down payment on a home, those funds shouldn't be invested in the market. Stocks are long-term investments, and there is no substitute for time.
Panic selling is a great way to shortchange your retirement.
If you sell at the first sign of a market drop, you could hurt your chances of retiring on time, says Mario Hernandez, principal and director of operations at Gemmer Asset Management. The closer you are to retirement the worse it is to sell during a market downturn, as you might not have enough working and investing years ahead to make up for the loss. Selling only locks in your paper losses and shortchanges your financial future. Worse still, it treats investing like gambling with no payoff, Hernandez says.
The herd is usually wrong.
Like cows in a herd, investors tend to follow the crowd. Human beings are hardwired to copy the actions of the larger group. This happens because investors think that if so many people are buying into the markets, they must be right. Even previously cautious investors jump back in, usually near the market's peak, only to panic and sell at the first sign of a downturn. This is a recipe for investing disaster, and it's why following the herd in such a time can lead you and your portfolio right over a cliff.
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