Financial markets are characterized by long cycles with many ups and downs. Successful investors block out fear and sensationalism and recognize that these market cycles are part of investing. In practically every bull market of the last 40 years, the U.S. stock market has experienced a correction during its rise.
The Dow posted its worst one-day point drop in history today (though not its biggest percentage drop). It was a classic panic-selling scenario. Here’s what you should do about it:
1) Know your history
Since 1900, the U.S. has seen 125 corrections of 10% or more, which averages out to about one per year. (A correction is defined as a 10% pullback, and though we haven’t reached that territory yet, we may be headed there.) Since 1980, the stock market has had positive annual returns in 28 of the last 37 years.
With that perspective, if your investing time frame is years or even decades from now, it may be best to hold tight and stay invested. Of course, there’s no guarantee that durations of future recoveries will happen in a similar time, or at all. But unless you have a need for the money in the short term, it might be prudent to just be patient.
Also, keep in mind that today’s drop was a 4.6% decline in percentage terms, but it followed a 25% rise in the Dow for 2017. Even after today’s drop, markets are still higher than they were a year ago. We remain optimistic about 2018, but believe we’re likely to see a bit more drama.
2) Look at market corrections as a buying opportunity
Historically, market downturns present us with some of the best opportunities to buy stocks or mutual funds at a discounted price. If a new car you had been wanting to buy were to go on sale at 10% or 20% off, you would probably consider making a move. If a stock or stock fund were to similarly go on sale, it may actually be an advantageous time to buy.
Moreover, most experts don’t see a recession on the horizon, which has been typically what it takes to ignite a bear market. Economic growth (in addition to corporate earnings) has been strong.
Research shows, however, that emotional selling is all too common. This is bad because investor behavior and poor decision-making can adversely affect returns. One study showed that the average individual equity investor had a 20-year average annual total return that was 4.20% less than the index, and that this gap was directly related to poorly timed decision-making.*
3) Make sure you are properly allocated
Take the opportunity to revisit your portfolio to make sure it is aligned with your time horizon and financial goals.
By developing a balanced portfolio of investments, you as an individual investor do not put all your eggs in one basket. This is known as asset allocation. A portfolio that mixes a variety of asset classes generally has a lower risk for a given level of return. Although it cannot guarantee a profit or protect against a possible loss, asset allocation, or diversification, can help spread the risk of investing because it broadens your investment base.
4) Take the long view
When people are told to think about the long term, there’s usually some confusion. How long are we talking about? To get a better idea, ask yourself how long you have until retirement or whatever savings goal you’re investing for.
If you’re looking at a retirement time frame of 20 years, you may experience two or three market cycles over that period. And those are full, long-term market cycles, not cyclical corrections in the market.
Remember that market cycles are a normal part of investing. Taking a short-term correction in the marketplace as a reason to change how you’re investing for a 20-year goal is ill-advised. Patience can be rewarded.
5) Have a plan
Remember that investing is a process, not an event. You should not make rash moves in response to market cycles.
Although you can’t control what happens in the stock market, you can control how you prepare and respond.
Market ups and downs are part of investing. The important thing is to stay invested, be patient, and stay diversified and disciplined with your long-term asset allocation.
If you want to discuss your risk tolerance, investment goals, and time horizon, or if you just want to take advantage of a buying opportunity, give our investment advisors a call at 888.86.AZZAD. We’d be happy to talk with you.
*DALBAR, Quantitative Analysis of Investor Behavior, 2014. Dalbar.com
Of course, investing involves risk and no strategy including asset allocation, rebalancing or diversification can guarantee a profit or protect against a loss in any given market environment.