Every once in a while the stock market suffers a schizophrenic break from its normal humdrum up a bit,down a bit daily routine. In late August and early September of 2015 we observed one of those psychotic episodes. Stock market investors were dizzy with vertigo from the wild daily fluctuations (mostly negative) of hundreds of points in the Dow Jones Industrial Average.
How can the average investor cope with a market downturn? Here are 9 things you’ll need to survive a stock market dive.
1. Calm, Long-Term Thinking
As a stock market investor, you are playing in a casino where the house edge is in your favor over the long term. However, you will experience a losing year occasionally.
Consider the S&P 500 index, a benchmark for investment returns for large-capitalization companies in the United States. From 1985 to 2015, the S&P 500 lost money in five out of 30 years, with losses as large as 37 percent in one year. The other 25 years ended in gains. Over the last thirty years, the long-term investor “won” five out of six years!
While you might be tempted to listen to friends, coworkers and talking heads on TV who will tell you now is the time to panic and sell because it’s bad, ignore that advice. Play the long game and you’ll be holding a winning hand in the end.
2. Good Council
If you rely on the advice of a money manager, now’s the time to talk to your advisor before making any impulsive decisions in your portfolio. Most likely you don’t need to do a lot to stay on track with your investment goals. Your advisor can talk you off the cliff of selling everything, so it’s worth a call if you’re having those thoughts.
3. A Stash of Income
For peace of mind, take a look at all the dividends your investments spit out on a routine basis. In a market crash, dividends typically don’t drop nearly as much as underlying stock values.
Let’s revisit the S&P 500 index again. The index value dropped by more than 50 percent from the peak in 2007 to the trough in 2009, whereas the dividends from the index dropped a more modest 20 percent during that crash. Whether you’re still working or in retirement, focusing on the income will help you deal with losses in a down market.
If you’re still working, your dividends can be reinvested to buy more shares at even lower prices during a downturn.
If you’re retired and living off dividends instead of relying on the sale of stocks to fund your living expenses, you would have faced a mere 20 percent reduction in income, if you held 100 percent of your assets in the S&P 500 index.
4. Reminders of True Value
Your shares are all still there, they are simply worth a little less during the downturn. A stock that drops from $100 per share pre-crash to $80 per share after the crash still represents the same claim to that company’s assets and future earnings.
While your brokerage statement will show a 20 percent loss in value on that position, you still own exactly what you did before the crash.
5. Diversification and Proper Asset Allocation
The best time to set up your asset allocation is before a major stock market downturn. But it’s never too late to get your portfolio properly allocated.
Holding the right proportion of diversified equities and fixed-income investments is key to keeping your portfolio’s volatility under control, according to how much risk you can stomach. If you panic easily and sell when markets drop big time, you should consider permanently increasing your allocation to fixed income investments like bonds, CDs, and cash.
Just don’t be tempted to go back to a high equities allocation the next time the market has a multi-year winning streak. That’s buy high, sell low, the exact opposite of what investors should do.
6. A Panic-Free Mindset
Does a declining stock market really affect your daily life? Will you be able to put food on the table next week and next month? Will your mortgage get paid on time? Will a tow truck show up at 3 am and repossess your car? Probably not.
You should never rely on strong stock market returns for your daily or monthly spending needs since the market is a long-term growth engine with a lot of volatility over the short term.
7. Market History
Zoom in on a chart of your favorite mutual fund, ETF, or stock and you’ll see lots of drops of 5 percent, 8 percent, 10 percent, or more. Zoom out to a multi-year time span and most of those corrections turn into barely noticeable downward blips on a generally upward trend line. Corrections happen routinely, although the broad market’s general trend is upward.
8. A Bottom Feeder Attitude
It’s hard to catch a falling knife on the way down, but give it a shot if you have surplus cash on hand. Market downturns are great times to pick up deeply discounted securities. You want to be buying when everyone else is selling.
You probably won’t pick the absolute lowest point of the market. However, getting shares at 10 percent off or more compared to what they were trading at just a few months earlier is a clear win.
9. Consistent Investing
As a corollary to “become a bottom feeder,” make sure you continue to invest regularly throughout a market downturn. Leave your 401(k) set to auto-invest just like it was before the crash. A downturn might last a month or it might last a year or more.
By letting your money dollar cost average into investments throughout the downturn, you’re guaranteed to be buying at low points compared to the pre-crash highs. I personally followed this strategy in the midst of the last major downturn in 2008–2009 and watched as many of my ETF and mutual fund positions doubled since then.
Throughout your investing career, there are going to be countless corrections and crashes. Sticking with your investments in good times and bad makes you an investor and not a mere market speculator or day trader.
Readers: how do you handle a market downturn? What’s one thing you need to keep a cool head?