One minute, the market’s hitting record highs. The next — blammo — we’re in the throes of a “sell-off,” or “right-sizing,” or whatever you want to call it. (Semantics is probably the last thing on anyone’s mind when you’re watching chunks of your 401(k) and IRA evaporate.)
Stock market declines are inevitable. Although history can tell us how long crashes, corrections and bear markets have lasted, no one gets a calendar notice announcing the time, nature and projected magnitude of future dips. But that doesn’t mean you can’t prepare for it.
Here’s a five-step game plan for what to do while you’re in the thick of it. Click the links for more advice — or read on:
- Trust in diversification: Smooth the trip through a tumultuous market.
- Remember your risk appetite: Keep today’s storm in context.
- Know what you own — and why: Is a good investment just having a bad day?
- Buy the dip: Gird your loins, gather cash and ease back into the market.
- Get a second opinion: Don’t let self-doubt sabotage your financial plans.
1. Trust in diversification
When a market decline hits, your results may vary — and perhaps for the better — if you’ve invested money across different baskets of asset classes.
Sit tight and trust that your portfolio is ready to ride out the storm.
If you’ve gone with a “set it and forget it” strategy — like investing in a target-date retirement fund, as many 401(k) plans allow you to do, or using a robo-advisor — diversification already is built in. In this case, it’s best to sit tight and trust that your portfolio is ready to ride out the storm. You’ll still experience some painful short-term jolts, but this will help you avoid losses from which your portfolio can’t recover.
If you’re a do-it-yourself type, even simple diversification (e.g. 70% of your money in an S&P 500 index fund and 30% in a diversified bond fund) will provide some cover during a crash.
When the dust settles you’ll probably need to make some adjustments to that mix (a.k.a. rebalance your portfolio) since it’s likely been thrown out of whack.
2. Remember your appetite for risk
Even though the stock market has its roller-coaster moments, the downturns are ultimately overshadowed by longer periods of sustained growth. That’s the reality on paper. If only our brains accepted that and didn’t trigger emotion-driven reactions — like selling during market dips and possibly missing the eventual uptick.
Investing in the stock market is inherently risky, but what makes for winning long-term returns is the ability to ride out the unpleasantness and remain invested for the eventual recovery (which, historically speaking, is always on the horizon). You’ll be able to do that if you know how much volatility you’re willing to stomach in exchange for higher potential returns.
» Read more: How Warren Buffett keeps his cool under pressure
Ideally, at the start of your investment journey, you did risk profiling. If you skipped this step and are only now wondering how aligned your investments are to your temperament, that’s OK. Measuring your actual reactions during market agita will provide valuable data for the future. Just keep in mind that your answers may be biased based on the market’s most recent activity.
3. Know what you own — and why
An emotional reaction to a temporary slump isn’t a good reason to dump an investment. But there are some good reasons to sell.
Part of doing stock research is crafting a written record of the strengths, weaknesses and purpose of every investment in your portfolio… and things that would earn each a place in the “out” box.
» Read more: Learn to find investments worth holding through the bad times
During a market downturn, this document can prevent you from tossing a perfectly good long-term investment from your portfolio just because it had a bad day. It’s like an investing road map — a tangible reminder of the things that make a stock worth holding. On the flip side, it also provides clearheaded reasons to part ways with a stock.
4. Be ready to buy the dip
Market dips are when fortunes can be made. The trick is to be ready for the fall and willing to commit some cash to snap up investments whose prices are dropping.
Be willing to part with some cash to snap up investments that are in the process of dropping.
You probably won’t catch the stock at its low, but that’s fine. The point is to be opportunistic on investments you think have good long-term potential.
Keep a running wish list of individual stocks you would like to own. Set aside some cash so you’re ready for a flash sale when disaster strikes.
» Read more: Here are smart ways to get started investing
Don’t be surprised if you freeze in place during the moment of opportunity. One strategy to overcome the fear of bad timing is to dollar-cost average your way into the investment. Dollar-cost averaging smooths out your purchase price over time and puts your money to work when other investors are huddled on the sidelines — or headed for the exits.
5. Get a second opinion
Being an investor is rewarding when the stock market’s on a tear and your portfolio is going up in value. But when times get tough, self-doubt and ill-advised tactics can take root.
Even the most confident saver-investor can fall victim to harmful short-term thinking.
Consider hiring a fee-only financial advisor to kick the tires on your portfolio and provide an independent perspective on your financial plan. In fact, it’s not uncommon for financial planners to have their own financial planner on their personal payroll for the same reason. An added bonus is knowing there’s someone to call to talk you through the tough times.