Contrary to popular belief, “cash is king” doesn’t hold up in the case of market downturns. Knee-jerk reactions to the stock market’s fluctuations and deciding to cash out your investments are common. However, if you’re not careful, it might cost you money and — worst case scenario — even your retirement savings.
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“Bailing out after big falls could cost you your retirement,” wrote Duncan Lamont, CFA and head of strategic research at Schroders, following early August’s market tumble. While the market has stabilized, volatility is part of the game — just look at the post-Labor Day tech stocks tumble. In turn, this makes it “harder to avoid being influenced by our emotions — and be tempted to ditch stocks and dash for cash,” wrote Lamont.
However, Schroders’ research shows that “the risk of near-term loss is the price of the entry ticket for the long-term gains that stock market investing can deliver.”
In other words, while investing in the stock market can be risky, rejecting the market after downturns “in favor of cash” can be detrimental to wealth-building in the long run.
Market Corrections Are ‘Normal’ and Inflation Erodes Cash
Chad Gammon, CFP and owner of Custom Fit Financial, agrees with the research’s premise, noting that investors are best served by avoiding heat-of-the-moment decisions during market downturns.
First, as he noted, the research highlights that while short-term stock market investments can be risky, the risk diminishes significantly over longer periods. On the other hand, while holding cash may seem safe, its value is typically eroded by inflation over time.
Stocks are generally a better option for long-term goals like retirement despite their short-term volatility. So, it’s important to remember that market corrections are normal, and the frequent occurrence of 10%+ declines are regular features of stock market behavior.
Finally, periods of fear can be opportunities. “The research also suggests that periods of heightened market fear, as indicated by the Vix index, often lead to better-than-expected investment outcomes if investors remain in the market rather than moving to cash,” Gammon said.
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Cashing Out Goes Against Basic Investment Principles
Bailing out on investments after a market downturn is also often a bad idea because it goes against investing’s most basic principle — buying low and selling high — explained Michael Collins, CFA, founder and CEO of WinCap Financial.
According to him, stock prices are typically lower when the market experiences a downturn, meaning it’s a good time to buy more stocks at a lower price. By bailing out and selling off your investments, you’re essentially locking in your losses and missing out on potential gains when the market recovers.
“This impulsive decision can also disrupt your long-term investment plan and hinder your overall financial growth,” Collins said.
Stephen Kates, CFP and principal financial analyst at RetireGuide.com, feels another risk in doing so is missing out on potential gains. “The best performance days are all clustered around the worst performance days and if you only end up participating in the drop, you will miss the rise,” Kates said.
So What Can You Do?
With all of the market volatility and possible retirement-wrecking possibilities, what should investors do to avoid hurting their retirement during market downturns? Here are some expert tips to keep in mind.
Diversify and Keep Focus on Long-Term Goals
One tip is to ensure your investment portfolio is well-diversified across different asset classes and sectors. In addition, Gammon stressed the importance of focusing on long-term retirement goals rather than short-term market movements.
“Diversification can help reduce the overall risk and cushion against significant losses in any one area,” he said. “Remember that retirement investments are typically long-term, so temporary market declines should not derail your overall strategy.”
Do Nothing
Bobbi Rebell, CFP and personal finance expert at Cardrates.com, said there is a simple solution to avoid hurting your retirement in market downturns: Just do nothing.
“What you should do is check in on how things are going at regular intervals and rebalance your investments to reflect any changes in your risk profile, goals and priorities,” she said.
Don’t Take More Risk Than You’re Comfortable With
Kates also noted that the best preventative measure for avoiding bailing on your portfolio and moving to cash is ensuring you aren’t investing riskier than you’re comfortable with.
“That’s easier said than done because there’s no set of questions or profiling that can predict how you’ll feel during the large and persistent negative performance,” he said, noting that if these semi-regular market drops cause you to feel panicky, you’re already risking too much.
Instead, build a portfolio you can confidently contribute to during downturns and build for the long term.
Work With an Advisor and Bucket Your Assets
Finally, working with an advisor helps assuage some fear and prevent emotional reactions. For instance, Tyler End, CFP, co-founder and CEO of Retirable, recommended bucketing your assets so the only money that’s invested and subject to market corrections is your excess income.
“Then, you can wait out the rebound without selling,” he said.
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This article originally appeared on GOBankingRates.com: Doing This One Thing During Market Downturns Could Cost You Your Retirement
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
