The Stock Market Dropped, Now What?

Those with a well-functioning crystal ball sold all their stocks, bonds, and cryptocurrencies at the beginning of this year. For everyone else, there haven’t been many places to hide. After last year’s tranquility, we are being reminded daily that investments can, in fact, decline in value. These periods can paralyze investors with fear, so it is a valuable exercise to step back and assess the situation objectively. Your perspective on the actions to take depends on a few things, but mostly the stage in your investment timeframe.

Try not to get anchored to high watermarks. We all want our portfolios to act as a socket wrench. With every turn of the wrench, a new point of progress is established with no pullback as the wrench reloads for the next turn. Unfortunately, investments don’t work like this, and drawdowns are inevitable. If you are worried about a specific investment being down X% year-to-date, zoom out and look at the progress made over the past few years. We were all spoiled last year with double-digit gains and minimal pullbacks – this year pulled us back to reality.

Think before you sell. It is very tempting to hit the eject button during times like these and wait out the storm in the relative safety of cash. Selling is the easy part – getting back in is where it gets tricky. Those crystal balls are in short supply, and typically when the time comes to buy back in, it won’t feel like it. As an example, consider the recent COVID crisis. The stock market bottomed on the day that most of the country entered into lockdowns. As the market goes higher, many who sold tell themselves to wait for a pullback to buy back in. That can be harder in practice than it is in theory. If you decide to de-risk, map out a plan beforehand and don’t make an all-in or all-out decision. Think of your portfolio as a thermostat and adjust as necessary.

Continue investing. The stock market is the only place where things go on sale and customers run out of the store. Pullbacks should be a welcome sight if you are still in the accumulation phase of investing. All else being equal, it makes more sense to buy stocks at 20-30% off, but it certainly feels worse. We want the positive feedback of putting money to work and seeing it immediately increase in value. Again, timeframes matter, so investing the money you need in the next year or two might not be the best strategy. Time is an investor’s best friend, and the lower prices you pay in the present set the stage for more significant returns in the future. 

I posted something recently on social media which illustrated the growth of the S&P 500 from February of 2020, right before everything hit the fan. Can you guess the total return over the last two-plus years? Twenty-two percent. If you average that out to about 10% per year, we are in line with historical averages. It was a heck of a ride, but here we are. Investments are meant to go through these periods, and approaching the decision-making process with perspective allows you to make prudent choices for your financial future. A financial advisor can add an objective voice.

Author: David Rath, CMT, CFA

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