What to Do When the Stock Market is Tanking
The stock market has been a bit scary recently.
You might be wondering whether you should sell everything. To stop the bleeding.
I’ll expand a bit more below, but I think the summary is fairly simple: Stick to your plan, as long as you have a well-balanced portfolio that’s appropriate for you.
Remember, nothing lasts forever. Whether that’s the stock market’s meteoric rise during most of 2020-2021, or the market’s decline this year.
As to when we’ll get through this particular decline, I don’t know. It could end tomorrow, or it could last through next year.
But if we look at the history of the stock market, the current downturn is completely normal. This is what the stock market does from time to time. Even though it’s painful, it’s important to remember that this is business as usual.
History also tells us that the stock market eventually recovers and goes on to create new record highs, driven by the same dynamics that make stock markets work in the first place. That’s also business as usual. And I want to make sure I’m invested for whenever that happens.
Now, let’s unpack that a bit.
First, the more technical (and, frankly, less important) stuff
Things do look concerning:
We’re most likely either in a recession or headed for one. That’s usually bad news for stocks.
Inflation, as we all know, has been running quite high. That’s usually bad news for bonds.
If there’s a recession at the same time as high inflation, both stocks & bonds will probably suffer.
So far, we’ve had a fairly “normal” correction for most of the stock market, but the more speculative parts of the markets have been hammered (tech stocks, meme stocks, Chinese stocks, crypto).
Having said that:
The answer to “will there be a recession?” is always yes. The question that’s harder to pin down is when one will occur.
One of the best ways to combat inflation is by holding stocks. Especially over longer periods of time, stocks are one of the main investments (along with real estate) that can keep up with (and overcome) higher inflation.
Nerdy thought: As noted above, bonds tend to do poorly at first with inflation. But bond funds are able to make up for the losses over time. As bonds in the mutual funds mature, the cash is reinvested in new bonds that pay a higher interest rate (due to interest rates rising). So, there is a natural leveling-out that happens over time, eventually leading to better returns after the initial losses.
Diversification & asset allocation
Investments go up. Investments go down. It’s hard to predict which ones will do well at any given time. That’s where the concepts of diversification and asset allocation come in:
Instead of trying to guess what’s going to happen, I much prefer to make sure my assets are diversified at a high level. This is an example of diversification.
If you’re appropriately balanced between the three major asset classes (Cash/Bonds, Stocks, and Real Estate), then I think you’re well-positioned for whatever may come. This is an example of asset allocation.
Note: Doing this doesn’t mean your portfolio won’t go down. It absolutely will at times, just like the farmer has a poor yield for their crops during some seasons. But it’s still best to keep planting those crops, because the yields could turn out great at any point, and you need the growth longer-term.
The role of stocks
It’s best to remember that any money you have in stocks should be for the long-term.
If you’re years from retirement, you won’t need that money for a long time. In fact, this downturn could actually be good news for you, assuming you’re continuing to save and invest. That’s because as you invest, each dollar goes further, buying more shares than it would have before. It’s like the market has gone on sale, at least compared to a year ago.
If you’re already retired, it might be helpful to think about your investments as being in buckets, with the spending for the next several years coming from safer assets (cash + bonds). Your stocks aren’t meant to fund your expenses now; they are for longer-term spending. See this post for background on that concept: Investment Buckets During Retirement
If you have money invested in the stock market that you’ll need in the next several years, it would be best to take it out of there if you’re worried about losing the money. The place to put that money is cash (and maybe bonds).
Remember, stocks are both fantastic investments for the long-term AND completely unpredictable for the short-term.
What to do?
My overriding principle when it comes to a topic like this is that I’m not in the business of trying to predict the stock market. Short-term predictions are more often wrong than they are right, even by otherwise-brilliant economists.
Speaking from personal experience, if I sold my stocks every time I was worried about the stock market, my nest egg would be much smaller.
The stock market has a way of fooling people. Fortunes have been made when things have looked the bleakest. The pandemic is the latest example of this. People were terrified of owning stocks in March 2020, but then the market went almost straight up for the next year and a half.
Further market downturns from here may even provide some interesting opportunities, such as rebalancing investments, tax-harvesting losses, Roth conversions, and investing extra cash at lower market levels.
Bottom line
As long as you’re properly allocated for asset allocation purposes, my approach would be to just ride this out. It may hurt in the short-term (or it may turn out great!), but, regardless, it’s the financially healthy thing to do.
Finally, I suggest turning off the noise. Ignore the headlines, as they’ll probably make you worry more than you need to. Headlines are short-term by nature, whereas your money in stocks is for the long-term.
