When the stock market experiences a decline and the value of your investment portfolio diminishes considerably, it is natural to contemplate whether it is prudent to exit the stock market. While this thought is understandable, it is often not the most advisable course of action. 

Rather, it may be more beneficial to ask the question, “What should I not do?” 

The answer is simple: Don’t panic.

Or better still, “What to do when the stock markets are down?”

Warren Buffett, the greatest investor in the world, says that it is wise for investors “to be fearful when others are greedy and to be greedy only when others are fearful.” 

He also says that Mr. Markets are manic depressive. They are cyclical. Things go up, things go down, more randomly and in more extreme ways, than the valuation of the underlying market. The stock markets are not always entirely logical. 

Why You Shouldn’t Panic

Panic selling frequently occurs as an instinctive response when stock prices are falling sharply, leading to significant declines in portfolio value. 

Therefore, it is crucial to understand your risk tolerance and how market volatility may impact your investments. Additionally, you can reduce market risk by employing hedging strategies through adequate diversification. This involves allocating your funds across a range of investments, including those that exhibit low correlation with the stock market.

Market crashes and economic downturns are part of life. As the COVID-19 pandemic showed, market calamity can occur seemingly out of nowhere. What is important is how investors handle that calamity. 

Stay positive. Do not let emotions such as fear and anxiety drive you to sell rashly in a falling market. Ensure you have sufficient cash reserves so that you are not forced to liquidate your investments for immediate funds.

Effective cash flow management, along with a good grasp of market dynamics, is crucial in these situations. Historically, after every market downturn, regardless of its severity, investor portfolios tend to recover from their loss in value. Markets will eventually stabilise and experience growth over the long run.

A case in point – the 2008 financial crisis led to a significant decline in the market, prompting numerous investors to liquidate their assets. Nevertheless, the market reached its lowest point in March 2009 and subsequently rebounded, surpassing previous highs. Those who sold in a panic missed the opportunity for recovery, while long-term investors who stayed the course ultimately benefited and saw substantial gains over time.

By staying invested, you can take advantage of lower prices to acquire additional shares. Such opportunities are not accessible to those who choose to sell during market declines, attempting to minimise their losses and remain on the sidelines.

What You Should Do When The Market Is Down

Instead of locking in your losses by selling at the lows during a steep market correction, formulate a strategy to protect your portfolio at such times.

Here are three steps you can take to avoid any reason to panic when the stock market goes down.

1. Understand Your Risk Tolerance

Many investors would likely recall their first encounter with a market crash which could have been unsettling, to say the least. This underscores the necessity of understanding your risk tolerance prior to constructing your investment portfolio, rather than during a market downturn.

This is very important and should not be overlooked – go to your financial planner if you need to re-evaluate your portfolio, your risk tolerance.

Your risk tolerance is influenced by several elements, including your investment timeline, liquidity needs, and emotional reactions to financial losses.

To get a gauge of your risk tolerance level, head to this tool at KarenTang.sg for an online assessment.

The duration of your investment strategy is a crucial consideration. For instance, retirees or those approaching retirement typically prioritise the preservation of capital and income generation, which may lead them to prefer low-volatility stocks or a mix of bonds and fixed-income assets. Conversely, younger investors often aim for long-term growth, as they have ample time to recover from potential losses during market downturns.

2. Prepare For and Limit Your Losses

It is essential to prepare for potential downturns and establish a robust strategy to mitigate losses.

Focusing solely on stocks can lead to substantial financial losses during a market downturn. To protect against these losses, investors often diversify their portfolios by incorporating various asset classes, thereby spreading their risk and minimising overall exposure. While reducing risk is important, it also involves a tradeoff between risk and return, which may limit your potential gains.

To manage downside risk effectively, consider diversifying your investments and including alternative assets like real estate, which typically exhibit low correlation with stock market performance.

The core principle of diversification lies in allocating a portion of your portfolio across stocks, bonds, cash, and alternative investments. Each investor’s circumstances are unique, and the allocation of your portfolio should reflect your individual risk tolerance, investment timeline, and objectives. A thoughtfully crafted asset allocation strategy helps prevent over-concentration in any single investment.

Implementing a strategy known as dollar-cost averaging allows you to invest in a disciplined manner without the emotions. 

• Dollar-cost averaging is the practice of systematically investing equal amounts of money at regular intervals, regardless of the price of a security. 
• This can be automated, for instance, at the end of each month when you receive your paycheck. 
• Dollar-cost averaging can reduce the overall impact of price volatility and lower the average cost per share.
• By buying regularly in bull and bear markets, investors buy more shares at lower prices and fewer shares at higher prices.

Work with a Certified Financial Planner who can hand-hold you, guide you in your investment journey. 

3. Focus on the Long-Term

Stock market returns can exhibit significant volatility in the short term; however, they tend to outperform nearly all other asset classes over the long haul. When viewed over an extended timeframe, even the most substantial declines appear as minor fluctuations within a broader upward trajectory.

This perspective is crucial to remember during challenging market conditions.

Maintaining a long-term outlook can also enable you to view a significant market downturn as a chance to enhance your portfolio with high quality, low cost assets. Treat it as an opportunity to acquire good quality stocks at favourable prices.

The Bottom Line

Selling in a panic during a market crash is more likely to damage your portfolio rather than improve it, as it effectively solidifies your losses. Understanding your risk tolerance, investment time frame, and the dynamics of the market during downturns is crucial. 

Keep calm and carry on! You need patience, not panic, to be a successful investor.

Come talk to me if you need a fresh perspective on how you can do better as an investor. Always here to ensure your financial planning & your wealth is well optimised.