What to Do (and Not Do) When the Market Drops

(Image credit: Ilya Terentyev)

It’s been a long time since we ended a year with U.S. stock market being down. However, the longest bull market in U.S. history, which started on March 9, 2009, could finally be coming to an end.

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If you have watched or read any amount of news recently, you haven’t been able to avoid the roller-coaster headlines over the last two months like, “Dow tumbles nearly 600 points” followed by, “Here's why the stock market was up today, extending a rebound.”

We are in a cycle of volatility, and it has many investors holding their breaths. Despite the bumpy ride the stock market has been on recently, remember that volatility is normal. As you continue to watch the headlines (and your portfolio balances), here are a few things you will want to do (and not do) when the market drops.

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What to Do When the Market Drops

Take a Breath

This is not to sound condescending. I know how difficult it can be to watch your portfolio lose thousands of dollars when the market takes a dive. You have to turn off the TV and stop scrolling through the headlines on your phone. There is nothing unusual about the market activity we’ve been seeing, despite the doom and gloom fed to you by pundits in the financial news media. Keep in mind, the media is motivated by ratings and clicks, and the worse they can make a story sound, the better it is for their bottom line.

In reality, the economic cycle is the natural fluctuation of the economy between periods of expansion (growth) and contraction (recession). Depending on which part of the cycle we are in, the stocks will be either rising or falling. There is no in-between. Now, the catch is that no one knows how long these cycles will last. If we did, investing would be a whole lot easier!

Still Saving for Retirement? Buy More Stocks via Dollar Cost Averaging

One of my favorite sayings, although I don’t know who said it, is that stocks are the only thing that people don’t want to buy when they are on sale.

Emotionally, buying into a market that is dropping is very hard to do. Don’t forget, though, that you want to buy stocks at a lower price and sell them at a higher price. When the market drops, you are able to buy stocks at a cheaper price. This is a good thing!

So, how do you ensure we are buying at the correct time? Well, there are no guarantees, but you can smooth out the bumps with a method called Dollar Cost Averaging. Dollar Cost Averaging is the practice of regularly investing a fixed amount of money regardless of market activity. This strategy lowers the average cost per share of an investment and eliminates the risk of a single investment at the wrong time.

In other words, take emotion out of investing and buy stocks on an automated schedule (same day and amount each month) to avoid any attempt to time the market. This way, your average price per share will even out over the long-term. It is the best way to avoid gambling with your future.

Already Retired? Cut Back on Your Drawdowns

If you are retired and drawing down on your portfolio, look to lower the amount of your distribution for a few months. Your original drawdown assumptions were likely made on a higher amount of assets. Lowering these distributions for a few months will allow you to reassess and make any necessary adjustments so that you can protect your retirement income.

Don't Settle for Anything Less Than True Diversification

What Not to Do When the Market Drops

Take Your Money Out of the Market

The one thing you definitely DON’T want to do when the market drops is to take your money out of the market! Resist the reflex to panic.

If you have heard it once, you have heard it a thousand times: No one, and I mean NO ONE, knows where the market is headed. You cannot time the ups and the downs. It might “feel” safer to get out now, but when do you get back in? You, in essence, could wind up making the worst investment move of selling low and buying high. Don’t do it.

When you are properly invested in a diversified portfolio that is designed with your goals in mind, according to your risk tolerance and capacity for risk, you shouldn’t pay attention to what the market does this month or that month. Your long-term investing strategy should already be accounting for such normal market fluctuations.

Conclusion

Whenever you look to make a drastic change to your portfolio, ask yourself: “Have my goals changed?” If the answer is no, chances are you should stay the course. If the answer is yes, it’s a good time to reconnect with your financial adviser and discuss potential updates to your long-term investment strategy. Your long-term financial success isn’t determined by one trading cycle.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Paul Sydlansky, founder of Lake Road Advisors LLC, has worked in the financial services industry for over 20 years. Prior to founding Lake Road Advisors, Paul worked as relationship manager for a Registered Investment Adviser. Previously, Paul worked at Morgan Stanley in New York City for 13 years. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network (XYPN).