In October 2018, the Dow Jones Industrial Average, a widely followed measure of stock-price performance of 30 of the largest U.S. companies, dropped 1,380 points in just two days. While that sounds scary, it was just a 5% move, taking the index back to mid-July 2018.
Still, you might have noticed that when your funds have been doing well, you feel pretty euphoric, but when they’re down, you feel a lot worse than the pleasure you felt when they were doing better. This is a psychological effect known as loss aversion, and it’s believed to be hard-wired into our brains.
The best way to respond to these emotional swings is to try to take emotion out of the equation altogether. Over long market cycles historically, markets have moved up, although, as always, they fall eventually. It’s that long historic sweep that you should focus on, not short-term movements.
You should also pay attention to the things you can control in investing and ignore what you cannot change. Here are a few tips to keep in mind:
- Diversify your investments. If you’re well diversified across stocks, bonds and cash, the likelihood of suffering significant losses may be lower. If your investments are concentrated, it’s like putting all your eggs in a single basket. If the basket falls, there’s a good chance that those eggs will be broken. But if you spread your eggs in multiple baskets, the risk that all will fall at the same time becomes significantly smaller (and the chance that one or more baskets will rise, also goes up)¹.
- Look at what’s behind the slump. There are lots of reasons why markets rise and fall, and they are not all tied to financial performance of the companies issuing stocks or bonds. It’s possible that the broad economy could be sagging, with low growth and/or high unemployment. Or a down market could be partly related to geopolitical events, such as unanticipated election results or instability in developed or emerging countries, or natural disasters.
- Don’t ignore your ability to sleep well. If, after examining your asset allocation to make sure it is aligned with your long-term goals and determining what’s behind market weakness, you still feel anxious about big market swings, you may want to revisit your stock allocation.
On balance, investing for retirement should be a fairly boring exercise. After all, it’s a process where results unfold over decades, not weeks or months. Often, the most important thing you can do when markets fall is… nothing. But you should do so only if the decision doesn’t keep you up at night.
¹ Diversification does not assure positive return or protect against losses in a declining market. All investing involves risk, including principal loss.
² Source: https://blog.circleblack.com/should-you-be-afraid-stock-market-crash. An investor needs to consider carefully the ability to maintain a regular investment program during an extended market downturn. Past performance does not guarantee future results.