In this article I share some opinions on why such drop is to be expected and offer some ways to stay afloat in such market conditions.
1 - Have a right perspective for this market drop
Majority of investors' fears were stoked by scary news headline such as 'Dow plunges 1,175 - worst point decline in history', 'Dow and S&P 500 now officially in correction'.
|CNN Money headline on 5th Feb|
But the fact is that US markets had one of the strongest bull run in history that lasted for 9 years since 2008 GFC. Plus, past 2 years' rise had been particularly relentless, from 16,000 to around 26,600, a 66% rise.
Even taking into account the last week's drop, Dow Jones is still up by 51% in past 2 years. So the magnitude of recent pull back is actually quite benign.
2 - Understand that market gyration is the norm
One can't expect stock market to rise in a straight line indefinitely, which means a consistent net buying volume (amount of purchase exceed amount sold), day-in-day-out non stop. It does not make sense. Surely one day buyers are going to dry up and when there is no buying, market will drop.
I read from some research (apologise that I really couldnt find the source so cant quote here) that on average, market will drop 10% once in around 18 mths, 20% once in 3-4 years, 50% several times in a century.
So being aware of these means that one should not be too surprised when recent drop took place. It's really as common as the sudden afternoon downpour despite a sunny morning in our local weather.
3 - Hasty investment decision usually turns out bad
When market drop so steep within such a short time, some could be lured into thinking that it is just a knee jerk reaction and market will spring back up as fast as it plunge. Some investors attempt to catch the rebound and earn some quick profits.
But often decisions made hastily could turn out bad. This happened last week when US staged a v-shape rebound to close 500 plus points up. Next day, investors poured in to buy the dip, but the morning market rise soon tapered off in the afternoon.
In summary such move is a difficult one especially during sharp market gyration like this.
4 - Good idea to sell all now to buy back later?
Some clients were so frightened by the fall that they wanted to sell everything and buy back later. My response to them was 'Do you know for sure that market will drop further? Even if it drops further would you really be able to buy back? And if market stop falling and rise back up how would you feel?'
Such move is rarely a good idea. Guessing market bottom and top is challenging enough in normal market conditions, leave alone during such high volatility.
*As of writing market is now up 42 points and up above 3,400. Be brutally honest with yourself. Would you be able to make a decisive action to buy now, or would you hesitate and tell yourself to observe first?
Actually many people just can't stomach the paper loss and large swing in portfolio value. Which brings me to my next point.
5 - Your mindset during this period matters a whole lot
Equities investing, besides the due diligence of selecting good company, is very often a psychological matter. For the core companies that you identified with good value and intend to hold for long, buy with an implicit knowledge that it will be worth much more in future to bring you great wealth, not with the expectation to earn xx amount of capital gain within 2 weeks.
I suspect it is the latter mindset that many investors entered the market with. With high expectation of earning quick bucks, they are not able to accept losses.
There are hell lot of a difference between them. Buying with implicit knowledge that it will be more valuable in future, you will be more at peace with price swing. You will not be hasty to earn and take profit, and consequently less perturbed when price does not rise as per you expected. But if one buy with high hope to earn within a specific time frame, its the exact opposite. And that leads to emotional instability that causes bad decision-making.
6 - Importance of risk management and a sound investment mindset
I hope this episode can really drill the importance of risk management and mindset/psychology into one's investing DNA.
When market is good, its easy to make money. Just 2 clicks to buy and sell. Even if price drops after we purchase, it will rise back. But all it takes is just one larger-than-usual market movement like this to undo all your profits.
Similar to our life, we buy insurance to hedge against major risks such as death, disability, critical illness. Investing should have insurance too - manage your risk, watch the downside well, be aware that market WILL DROP BIG once in a while and always be prepared.
What should an investor do now?
In all honesty no one can tell you exactly what to do with your portfolio and shares. In order to do that he has to know full details about your investments: portfolio size, allocation, risk preference, rationale of buying etc.
However there are still principles that we can adopt.
Firstly, ensure that your overall personal finance and cash flow management still intact - there is regular savings going into your investment account. Then you can buy cheaply when market offers you an even better price than now.
Go back to your investment plan. By investment plan I mean the tactical moves you would make under various scenario of price movements. Example how much more to buy at a particular lower level price, where is the stop loss, where to take profit, should you re-balance etc.
If you are the pure fundamental investor that look at only company's performance, simple. Are the companies still strong fundamentally? If yes, keep. If not, consider selling.
If you are still upset by the paper loss, consider reducing the size of that position. Sell partial, or fully, till you can sleep soundly at night. Being mentally disturbed by your portfolio is a big no no in investment.