Days like yesterday are shocking for investors. The Dow fell over 800 points, representing a drop of over three percent, while the Nasdaq fared even worse on a percentage basis losing over four percent on the day.
Those are scary numbers, and most people’s reaction is to immediately start analyzing the possible reasons for the big drop. That makes for interesting TV and reading but is essentially useless to most investors. We can do nothing about what happened yesterday.
All we can do is decide what to do now and what to do in the future, and that decision should be made with three important things in mind:
1. Markets Go Down as Well as Up
For a while a few years back, I worked as a financial advisor at a major Wall Street firm. In the office where I worked, as there probably is in every office, there was a guy who had worked at the job forever. He was a legendary not just for his experience and massive book, but also for his short, sharp, often unfriendly demeanor. He flew in the face of the conventional wisdom that advisors had to be “likeable” above all else, and that the customer was always right. Initial meetings consisted of him interviewing the prospect rather than the other way around, and he would only accept new clients if they understood some important things.
I knew him socially before joining the firm, so knew him to be a nice guy outside of business, his grumpy manner presumably coming from being tired of being asked the same, stupid questions for decades. Over the years, he had developed stock answers to those questions. My personal favorite was when prospective clients would ask him where he thought the market was going. His reply? “Up and down.”
He was never wrong, of course, but his answer made an important point. The stock market trends upwards over time, but it never moves in a straight line. Understanding that helps you to ride out the inevitable down periods and stick to a plan that allows for volatility. That involves at the very least regular re-balancing of a portfolio, and ideally taking some profit during the good times to free up cash for when stocks get cheaper.
2. Things Often Seem Worse than they Really Are
For those of us of a certain age, hearing that the Dow dropped 830 points in a day is traumatic, if only initially. We tend to think of in terms of days like October 19, 1987, known as “Black Monday”, when the Dow lost 508 points. The difference is that on Black Monday, the index lost over 22 percent of its value that day, but yesterday's rout represented just over a three percent drop. A few hundred points here or there are just not what they used to be.
It often seems like they are though, for two reasons. One is that we have been spoiled for so long. The market has been climbing for nearly a decade, and while there has been volatility during that time, recoveries that have reasserted the upward trend have come quickly. In that context, a sell-off feels worse than it is.
The second reason is that we live in an age of constant, competitive coverage of news, including of the financial variety. That encourages breathless, sensational coverage of even modest market moves, so a drop like yesterday’s is covered ad nauseum, and the hunt for clicks and eyeballs results in frequent predictions of doom.
Even if the stories are sensible, a plethora of headlines like this and this that, based on the evidence of one day of trading mention the end of a nearly decade-long bull market can easily cause investors to panic.
3. Don’t Panic!
In many ways this is the most important thing to remember at times like this. I worked in a dealing room for nearly twenty years, and I can assure you that watching others panic is a wonderful thing. You can do so in the certain knowledge that they will be selling at or near the bottom, then chasing the market back up again, locking in a loss that you can pocket. Don’t be that person!
Think about it logically. Even if the selling continues, the recovery will likely be swift. Even recent experience shows that. We experienced three big drops like this in February oh this year but were back to new highs just six months later. The chances are that this will once again be a rapid move down and a rapid recovery, given the state of the economy.
Even if you believe that a couple of minimal interest rate hikes will prompt a recession, it is unlikely to be as deep as the last one. That was the largest since the 1930s, and the market fully recovered from that in around four years. It makes more sense given that to start looking for things to buy on the way down than risking selling into a small, temporary move down.
The only logical reason to sell into a move like this is that you will need the invested funds very soon, for retirement or whatever. If that is the case, though, you should probably not be invested heavily in stocks at this point, so selling is a good idea whatever happens. Other than that, though, remember that as dramatic as yesterday’s move seemed, it is well within the bounds of a normal move, and should not prompt investors onto any drastic action.