Know when to do nothing
You should know the signs of a downturn so you can sell quickly, right? False. See what I say about this money myth in the 30-second video below.
Doing nothing is doing something
I have a 2-year-old and I work as a financial advisor, so I’m familiar with volatile, unpredictable, and inconsistent behavior—from the toddler and the markets. In both cases, I know the behavior is normal and I expect it. When it happens (and it does), I stay calm. I don’t give in. And most of the time, I do nothing.
I consciously decide to do nothing during a market downturn. My inaction isn’t the result of indecision, though. It’s based on what I know:
Market conditions change quickly. Record lows (or highs) can be here today and gone tomorrow. For example, U.S. stocks returned about ‒14% in the fourth quarter of 2018. But the market recovered quickly. In the first quarter of 2019, U.S. stocks returned about 14%.* In fact, the S&P 500’s gain during the first quarter of 2019 is its best quarterly gain in almost 10 years. Although a rebound of this magnitude may be a bit of an anomaly, it definitely goes to show that market conditions can change quickly.
You should trust your asset allocation. If you have an asset allocation that’s based on your goals, risk tolerance, and time frame, you should have confidence in your portfolio’s ability to handle market turbulence. I test my clients’ portfolios to see how their asset mixes hold up in thousands of hypothetical market environments. Time after time, these “stress tests” verify that the right asset allocation will support your goals, even under the strain of external stress factors.
You have to give your portfolio the chance to recover when the market recovers. Consider the example above. If you sold U.S. stocks at the end of 2018 because the market was down, you would’ve locked in a 14% loss. If you stayed the course, the value of your U.S. stock holdings would’ve almost completely rebounded the next quarter.
Buy and hold … and rebalance
Doing nothing in the face of a market downturn isn’t equivalent to keeping your head in the sand. In fact, being aware of market downturns can help you identify opportunities to rebalance your portfolio back to your target asset allocation. Rebalancing regularly (or when your portfolio allocation drifts from your target by at least 5 percentage points) is an easy way to maintain your asset allocation so you can control your risk exposure.
If you have a money myth you’d like to share, please comment below.
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*Stock market figures are based on the Dow Jones U.S. Total Stock Market Index.