What to do when the Stock Markets are down?
Investors around the globe often react with concern when the stock market declines and their portfolio value takes a significant hit. They may find themselves contemplating whether it is the right time to exit the stock market. That's understandable, but probably not the wisest choice. Today, we encourage investors to reflect on the actions they should avoid, such as selling all their stocks in a panic or making drastic changes to their investment strategy. Remember, stability in your investment strategy can provide a sense of security during market declines.
First and foremost, it's crucial to maintain a calm and composed mindset when the stock markets decline. This is not just a piece of advice, but a powerful tool that can help you make rational decisions and reassure you that you are in control. It's worth considering whether purchasing more stocks is a viable option, and our response would be "Maybe."
Based on our experience, it is common for individuals to react impulsively and sell their stocks when there is a significant decline in their portfolio's value. At Innovest Global Wealth (IGW), we highly recommend that investors have a clear understanding of their risk tolerance and how price fluctuations or volatility may impact their investments. It is crucial to be well-informed about these factors in order to make informed investment decisions. Additionally, we strongly advise investors to consider diversifying their investment portfolio as a means of effectively managing market risks. Diversification is like a safety net, ensuring that your investments are spread across a range of assets, including those that are not closely tied to the stock market. For instance, a well-diversified portfolio will include a variety of investment options such as government and corporate bonds (both in foreign and local currencies), structured notes, stocks, mutual funds, and other similar products.
But why invest in stocks? In general, most global investors or individuals do not choose to invest in stocks. One possible explanation is a decrease in trust and understanding of the stock market, especially following the 2008 financial crisis. Stock market participation experienced a significant decline following that crisis. In times of economic downturns, such as during a recession or a global event like the COVID-19 pandemic, the fundamental principles of investing, such as one's ability to handle risk and the need for diversification, are often challenged. At IGW, we strongly emphasise the importance of investors gaining a comprehensive understanding of various investment opportunities and products. By doing so, investors can gain valuable insights into the cyclical nature of the stock market and the inevitability of market declines. However, a downturn is only temporary. It is more prudent to consider the long-term perspective rather than making hasty decisions to sell when stock prices are at their lowest. Remember, patience is a virtue in the world of investing.
The Impact of Market Cycles
Experienced investors understand that the market and economy will inevitably bounce back, so investors must be prepared for this recovery. The 2008 financial crisis serves as a powerful example. Despite a significant decline, the market reached its lowest point in March 2009 and eventually rebounded, surpassing its previous levels. Those who succumbed to panic and sold their investments missed out on the subsequent recovery. This underscores the potential consequences of panic selling during market downturns, as it can lead to missed opportunities for recovery and long-term growth. In March 2020, there was a notable event where the S&P 500 saw a substantial decline of 35% in a span of slightly over four weeks. This decline happened as the stock market entered a bear market for the first time in 11 years owing to the global pandemic. The index not only swiftly rebounded from those lows but has also achieved record highs on multiple occasions since. In 2022, there was a noticeable decline in the stock market from the previous highs observed post-pandemic, and the volatility continued into 2023. Throughout the first half of 2024, it reached even more impressive peaks.
So, what actions should investors take when the stock market experiences a decline?
Instead of selling at lows when the markets are down, IGW encourages investors to develop a bear market strategy to safeguard their portfolios and avoid locking in losses. Here are three steps recommended by IGW to stay calm and composed during market downturns.
1. Assessing Your Risk Tolerance
It is essential to clearly understand your risk tolerance before setting up your portfolio, rather than waiting for a market sell-off to make decisions.
Several factors contribute to determining your risk tolerance, including your investment time horizon, cash requirements, and emotional reaction to losses.
Try the complimentary Innovest Investment quiz that can help you gauge your risk tolerance.
The time horizon for your investments is a crucial consideration. Individuals approaching retirement or who have already retired are primarily concerned with safeguarding their savings and generating a steady income during their retirement years. It is advisable to consider low-volatility stocks or a portfolio of bonds and other fixed-income instruments. Younger investors may choose to invest with a focus on long-term growth, taking into account their more extended time horizon to recover from any downturns in the market.
2. Be proactive and take steps to minimise potential losses.
In the end, it is vital to be prepared for the worst and have a well-defined plan to protect yourself from potential losses. Putting all your money into stocks can result in substantial losses if the market experiences a downturn which doesn't fit into your timelines. IGW encourages investors to strategically diversify their portfolios to mitigate potential losses and minimise overall risks. When you aim to minimise risk, you inevitably encounter the tradeoff between risk and return. Your potential for gains may decrease.
Spreading your investments across different assets and considering alternative options like real estate, which tend to have little connection to stock market movements, can minimise potential losses.
IGW introduces investors to a diverse selection of investment solutions, which is crucial to maintaining a well-balanced investment portfolio that carefully weighs risk and reward. We also recognize that each investor has a unique situation, and your individual risk tolerance, time horizon, and objectives determine the allocation of your portfolio. Implementing a carefully planned asset allocation strategy will help you diversify your investments and minimise risk.
3. Think and invest Long-Term.
Stock market returns can exhibit significant fluctuations in the short term, yet they consistently surpass the performance of nearly all other asset classes in the long run. Over an extended period, even significant declines appear as minor fluctuations in a continuous upward trajectory.
Therefore, when investing in stocks, think long-term.
Having a strategic perspective will also enable you to view a significant market decline as a chance to enhance your top-tier investments. For example, you could view it as a chance to acquire certain high-quality stocks at appealing valuations.
Another option to consider is dollar-cost averaging, which can help to even out any fluctuations. This entails buying the same amount of an asset at regular intervals, like monthly. The price per share of your purchase will vary over time, but your average cost per share will likely be lower.
Frequently Asked Questions (FAQs)
Is it more advantageous to purchase stocks when their prices have decreased?
Investing in stocks during a market downturn can prove to be a wise move, provided you choose the right stocks. You can acquire some top-performing stocks with strong potential for long-term success. Avoid weaker stocks that have benefited from the market's rise.
The same principle must be considered when deciding to sell during a market downturn. If the stock appears to be a long-term underperformer, it might be prudent to exit your position while you still have the opportunity. If it's a long-term winner, selling prematurely solidifies your loss.
IGW can provide you with insights on potential high-performing stocks that have the potential to impact your portfolio significantly in the coming years.
Is it advisable to invest in the stock market if I have plans to use the money to purchase a house within the next year?
Emphatically NO!
Long-term commitment is crucial for successful stock market investing. Considering the market's short-term fluctuations, it may be tempting to invest in stocks for less than a year during a bull market. However, it's important to remember that markets can be highly volatile over shorter periods.
If you require funds during market downturns, you may have to sell your investments at an unfavourable moment.
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