5 Questions to Get You Through the Market Decline

"Don't you see what's happening? Potter isn't selling. Potter's buying! And why? Because we're panicking, and he's not. That's why. He's picking up some bargains. Now, we can get through this thing all right. We've got to stick together, though. We've got to have faith in each other." – George Bailey – It’s a Wonderful Life, 1946

We’re talking Old Man Potter here, not young Harry Potter. And while Mr. Potter remains an unsavory cinematic character familiar to generations of Americans, he did have a fair amount of business acumen, perhaps even a lesson for today’s investor.

Now, in spite of the market’s less-than-stellar start to 2016, I will not be one of those guys who insists that the market always bounces back. It doesn't. This dip might very well be followed by a much lower market. Our own research shows… Actually, never mind that for now.

Whatever happens over the short or long term, investors should heed George Bailey’s advice: take a breath and relax. Panicking is never the answer. Instead, take this moment to re-examine why you are investing in the first place.

1. Are you a long-term investor?
2. Do you need money for a specific purpose?
3. How much exposure do you have to the market?
4. Are you investing for dividend income?
5. Do you believe this decline is the beginning of a long-term trend?

Understanding the answers to these key questions may help alleviate some worries during market downturns.

1. Are you a long-term investor? If you say you are a long-term investor, but you want to sell at the first decline, you might not really be a long-term investor.

What does it mean to be a “long-term investor”? If your target is ten years or more into the future, you are a “long-term investor.” Maybe you should analyze your investments and consider where they will likely be in a few years -- not a few minutes.

Warren Buffett is famous for saying, "If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes."

2. Do you need money for a specific purpose? If you know that you will need cash within the next 12 to 18 months, it is a good idea to keep that money liquid. Leave the $25,000 you have earmarked for a new roof in a money market. A $500,000 portfolio may allow you to re-allocate the $25,000 you need, without liquidating the entire portfolio. Just make sure the cash you need is tucked away safely; being fully invested at all times is not worth your new roof.

3. How much exposure do you have to the market? If only 20% of your portfolio is allocated to stocks, there may be no reason to sell out of everything. Depending on your holdings, a drop of 10% in the market might translate to only a 2% drop in your portfolio. Before you panic, check your allocation. You might be surprised.

Now, if you are the type of person who cannot stand to see their portfolio drop even the slightest, maybe you should re-think your investment choices altogether. The market might not be right for you.

If you are a trader, well, these are the breaks. This is the part they don’t tell you about on all those discount stock-trading commercials. If you aren't willing to take some losses, maybe you shouldn't be a trader.

4. Are you investing for dividend income? If so, would it really be wise to sell everything now? You still need the income. You will not be able to replace that income in a money-market or bank account. Take this opportunity to evaluate the ability of those companies to continue paying dividends, and re-balance your portfolio to make sure those companies have good coverage ratios on their dividends.

Ask yourself questions about each holding. Do you really think XYZ Corp is going out of business? Or might it just drop another 20%? Can you handle seeing XYZ Corp drop? Where do you think XYZ Corp might be in five or ten years?

5. Do you believe this decline is the beginning of a long-term trend? If you believe that a long-term bear is approaching, hopefully, you have already begun selling off riskier positions. Otherwise, you may be stuck. It depends on how bad you think things could get.

Do you see this decline lasting months or years? Take heart: many long-term bears have substantial rallies. You can use those rallies to lighten up on your positions.

Do you believe there is the potential for a market crash? Lighten up your positions as soon as possible -- regardless of price. Losing everything is much worse than selling at a loss.

Right now, the best thing everyone can do is re-examine why they are investing, and be patient. Patience can be an investor's best friend during times like these. Waiting for selling opportunities may get you out of positions at a better price. Sitting in cash while the market drops may allow you to pick up bargains that others, who stayed fully invested, cannot.

Emotions can be your Achilles heel. Emotions can cloud your judgement and force you to make bad decisions. Emotions can take a good long-term investment plan and turn it into trash.

However, re-adjusting and re-balancing, while being patient and aware of your emotions, is perfectly fine. You may need to lighten up on your equity exposure if you believe the market will continue much lower. Do some investigation; look at valuations, trends, fundamentals and future prospects or seek recommendations from an expert.

Notice that “panic” is not an option. That is what George Bailey desperately tried to tell the crowd and the lesson that Potter can teach today’s investors: Panicking will not make the decline any better, and it is certainly not a sound investment strategy.

Disclosure: Third party posts do not reflect the views of Cantella & Co Inc. or Cornerstone Investment Services, LLC. Any links to third party sites are believed to be reliable but have not been independently reviewed by Cantella & Co. Inc or Cornerstone Investment Services, LLC.Securities offered through Cantella & Co., Inc., Member  FINRA/SIPC.  Advisory Services offered through Cornerstone Investment Services, LLC's RIA. Please refer to my website for states in which I am registered.

John Riley, registered Research Analyst and the Chief Investment Strategist at CIS, has been defending his clients from the surprises Wall Street misses since 1999.