What typically happens when the market drops substantially?
Investors tend to panic because of the sudden shock, their assets have dropped substantially and they lack clarity about what happens next. Immediate plans become disrupted. For example, retirements or new home purchases may get delayed. Savings models become adversely affected because it might require substantially more savings to meet goals.
Instincts tell us to do something to avoid more losses. However, if you planned ahead and have a reasonable asset allocation, you can ignore those instincts. For those investors, they view a significant market decline or crash as creating opportunities because their portfolios guard against these significant swings.
What are my practical options?
- Do nothing, let the market settle and continue as though nothing happened.
- Rebalance, essentially buying more of the things that dropped in value with those that did not drop or possibly appreciated in value.
- Use the cash you set aside to buy at a discount, effectively changing your asset allocation to have less cash and more of whatever you think has better value.
Let’s explore each option in detail.
Doing nothing is perfect for the passive investor because it lends itself to market-timing avoidance, which is when most mistakes are made. Simply leaving your portfolios to the market throes is far superior to overreacting and selling at the most inopportune time. Historically, markets recover and it simply becomes a matter of time before it occurs. To quote John Bogle, stay the course.
Rebalancing your portfolios offers an opportunity to buy more holdings at a discount while restoring your portfolios to their original asset allocation. Not only does this reduce risk, it facilitates buying low and selling high – every investors dream. John Bogle rebalanced whenever one of his holdings strayed from his asset allocation by ten percent.
Modifying your asset allocation by lowering cash and increasing another asset class while simultaneously employing rebalancing, positions you for the best value. The cash component would have dropped less – most likely not at all. Combined with selling other assets that might have appreciated during the crash positions your portfolios for maximum gains. Suppose you previously did a five percent tactical shift from equities to cash prior to the crash. In that case, you may want to undo that shift, reverting back to your original asset allocation. A word of caution, this strategy is for savvy investors, those who know fair prices relative to market levels. Shifting back too soon simply means you are paying too much for what was once overvalued to begin with. Short of knowledge, undo the shift by dollar cost averaging over several months.
Each option is practical and each one gets progressively more active, but grow with potential.
Crashes bring anxiety, loss, destroy the economy, ruin businesses and puts stress on families among other things. Every investor’s portfolio, if built and managed properly, can withstand these adverse market conditions. It is not complicated and a company like Track My Portfolios helps you maintain your balance in good times and bad - reducing anxiety, lowering risk and increasing your net worth. Their market research also helps you decide if stocks are fairly valued.
The interesting thing is that we all get attached to the proverbial high-water mark of our assets. It becomes the baseline and will do anything to protect it or even take on additional risk to get back to where it once was. Markets ebb and flow, so do not succumb to emotions. It is better to plan each portfolio according to risk, create a reasonable asset allocation for each and rebalance at the most opportune time – on your terms.
In summary, market crashes bring investment opportunities to those who planned in advance and who are resilient during adverse times.
Good luck and may you achieve your life goals.
G. Michael Kennedy
Financial Strategist
Family Financials