Market declines are a feature of investing, not a bug. Of course, it doesn’t feel that way. We are hardwired to feel the pain of a loss, even when it’s just on paper. Nobel Prize-winning psychologist Daniel Kahneman demonstrated this with his loss aversion theory, showing that people feel the pain of losing money more than they enjoy gains.
The natural instinct is to flee the market when it starts to plummet, just as greed prompts people to jump back in when stocks are skyrocketing. Both can have negative impacts.
To help you navigate market declines and volatility, here are five key strategies to keep in mind:
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Stick to Your Investment Plan
Your investment plan was created for a reason, with a long-term perspective and specific goals in mind. Market fluctuations are part of the journey. Abandoning your plan during a downturn can lead to missed opportunities and potentially locking in losses. Revisit your plan to remind yourself of your long-term goals and the strategies in place to achieve them.
The following chart shows intra-year stock market declines (red dot and number) and the market’s full-year return (gray bar). Since 1980, the average decline was 14.2%, yet annual returns were positive in 33 of those 44 years (75% of the time!). It highlights that the market often recovers from drops and ends the year positively, encouraging investors to stay the course during volatility.
Source: JP Morgan Asset Management
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Maintain a Diversified Portfolio
Diversification is one of the most effective ways to manage risk. By spreading your investments across different asset classes, sectors, and geographic regions, you reduce the impact of any single investment’s poor performance on your overall portfolio. Regularly review and rebalance your portfolio to ensure it remains aligned with your risk tolerance and investment goals.
Check out this article on diversification to learn more.
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Focus on the Long-Term
Market declines are often short-term events, while your investment goals are likely long-term. Historically, markets have recovered from downturns, and staying invested through the tough times can help you benefit from the subsequent recoveries. Avoid the temptation to time the market, as it’s nearly impossible to predict the best times to buy and sell.
In fact, this reaction can be costly, as the best days in the market often follow the worst. This chart compares a fully invested individual in the S&P 500 over 20 years with those who missed the best days. Missing just the top 10 days halved the annualized return; missing the top 40 days led to a negative return on a $10,000 investment. Staying invested with a diversified, long-term strategy may lead to better retirement outcomes.
Source: JP Morgan Asset Management
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Assess and Adjust Your Withdrawal Strategy
For those nearing or in retirement, market declines can be particularly concerning. It's crucial to have a well-thought-out withdrawal strategy that can withstand market volatility. Consider the following:
- Maintain a Cash Reserve: Keep a portion of your portfolio in cash or short-term investments to cover at least 3-6 months of living expenses, but some people may benefit from having enough to cover 1-2 years. This can help you avoid selling investments at a loss during a downturn.
- Review Your Withdrawal Rate: Ensure your withdrawal rate is sustainable. A commonly suggested rate is around 4%, but this may need adjustment based on market conditions and your personal situation.
- Be Flexible: Be prepared to reduce discretionary spending during market downturns. Adjusting your withdrawals in response to market conditions can help preserve your portfolio’s longevity.
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Stay Informed but Avoid Overreacting
Keeping informed about market trends and economic news is important, but it’s equally crucial to avoid overreacting to daily market movements. Media coverage can often amplify fears and lead to hasty decisions.
Consider this chart of the S&P 500’s performance since 1970 and the events that have occurred since then. Looking at all the crises that the market has withstood can help put things into perspective.
Therefore, focus on the fundamentals of your investments and trust the process. Consult with your financial adviser if you need reassurance or a second opinion.
Bottom Line
Market declines can be unsettling, but they are a normal part of the investment cycle. By sticking to your plan, maintaining diversification, focusing on the long term, making temporary adjustments and staying informed without overreacting, you can handle market volatility with greater confidence.
Remember, the goal is not to avoid market declines but to manage them wisely and stay on course toward your financial goals. If you have concerns or questions about your investment plan, schedule a free investment consultation with an Advance Capital Management financial adviser right now.
