If you are invested in the stock market today, you will have had a rough ride, even investing in the stock market through low-cost passive index funds.
Every time the stock market wobbles, the newspaper headlines, and other media report it as a pending disaster. Playing on people's emotions and making them take action by panicking and fleeing to the safety of cash, but this is probably the worst thing you can do. The business of the media is to sell papers or to get you to click and read their articles, not to help people become good investors.
So, how should you react to a stock market fall…what is the secret method for dealing with a
market crash? Read on...
Market crashes are normal
First, it is important to remember that market crashes are normal. These drops in value are paper losses and only become real losses if you sell.
Market crashes are to be expected and have happened plenty of times before and will happen plenty of times again in the future. History shows the stock market has always recovered, and if it doesn't, then no investment will be safe; there will be more to worry about than your retirement pot - tins of beans and bottles of water will probably be more important at this point!
If you are experiencing your first market drop and are struggling, then it might be worth revisiting your asset allocation at some point in the future and adjusting based on your risk tolerance - but now is not the time to be doing this.
How should you react to a stock market fall?
DON’T PANIC AND DON’T SELL. STICK TO THE PLAN!
Once you have created your personal financial plan, and executed it, the best thing you can do is NOT think about it.
Fidelity reviewed the performance of customers from 2003 to 2013 and found the accounts that had made the best gains were owned by customers who were either dead or inactive and had forgotten about their accounts!
The stock market is volatile, the past few years have clearly demonstrated this. Volatility tempts investors to sell in fear, usually when prices are already down, then buy back when prices have already gone up.
Volatility also tempts investors to speculate, effectively becoming short-term gamblers on the stock market. Speculators trade frequently in the hope of timing their buys and sells to coincide with peaks and troughs. However, in reality, buying at lows and selling at highs is easier said than done.
Inactive investors, on the other hand, ride out the short-term volatility of the market whilst staying invested. With the stock market historically going up over the long-term, investors who have simply sat tight and held on to their investments have done extremely well.
Peter Lynch, one of the greatest investors of all time (he ran Fidelity's legendary Magellan fund and achieved an astounding 29% annualised return for 13 years) stated:
"Far more money has been lost by investors trying to anticipate stock market corrections than has been lost in all the corrections combined"
One of the worst mistakes you can make is switching in and out of the market hoping to avoid a crash, trying to time the market. Hence the well-known saying:
It’s time in the market, not timing the market
Almost all investing mistakes are made when greed and fear overpower logic and reason.
Market downturns barely register when taking a long-term perspective. None of us know what the future holds, what we do know is that markets move in response to an unfathomable number of ever-changing variables. At the same time, we know that investing in shares and bonds has a strong and lengthy track record of delivering inflation-beating returns in the long run.
This is why 'time in the market' will always be more important and effective for investors than trying to 'time the market'. It is also why investors experiencing losses should stay calm and remind themselves of their long-term goals. Stick to the plan!
A study by Nick Maggiulli from the blog ‘Of dollars and data’ shows that even perfect market timing in a 50 year period only results in being 22% better off at the end of this long period, or 0.4% per year, and this is the result of perfect 100% hindsight!
Stick to the plan
Sticking to your financial plan is the most important part of your plan. Your job as an investor over the long-term is to buy and hold and avoid selling as much as possible. Frankly, the more you tinker, the more stressed you will be. The more stressed you are, the worse your decision-making will be. The more you overthink things, the worse your portfolio will perform. This is why you write down your financial plan so that you can remind yourself what you need to do.
Let’s face it. When the market crashes there are only 3 moves you can make. In order from dumb to magnificent (a reference to The Magnificent 7 Rules), here are the options:
1. PANIC AND SELL: YOU, not the markets, turn a temporary decline into a permanent loss!
2. Do nothing: sit through the temporary decline and stick to the plan.