The stock market moves in cycles. There are up phases and down phases. And at the risk of painting broad generalizations, retail investors have a tendency to panic and sell those down phases, while institutional investors see cheaper prices as buying opportunities.
There may be a cost to selling: the panicked sale of a long-term retirement investment during a down phase could hurt long-term investing results. What’s more, when markets recover, the shift often occurs rapidly, meaning investors might miss the bottom.
"Investors who try to time the markets generally do worse than those who stick with a strategy that fits their risk tolerance and time horizon and rebalance with market moves," says Derek C. Hamilton, certified financial planner at Elser Financial Planning.
"Profitably timing the market is very tough to do. Suppose you do get out of the market at the right time. When do you get back in? What do you buy when you do? You would be very lucky to get just one of these right, but the odds against the trifecta are terrifying," Hamilton says.
Here are five strategies that long-term investors—especially those saving for retirement—might consider during a stock decline to avoid an ill-timed rush to the exit.
1. Pick and stick with a plan. Before a down phase begins, create a long-term investing plan that outlines your goals, risk tolerance, and time horizon. Determine why you are investing. Develop a process of investing that you’ll follow no matter what the market phase. That could involve regular monthly automatic contributions to your retirement plan. Learn how to build a diversified portfolio with different asset classes. A well-diversified portfolio is one defense against a stock down phase. Some advisors suggest you rebalance your portfolio on a semiannual or annual basis to determine if your stock/bond/alternatives mix has changed due to market movements.
2. Enlist the pros. A financial advisor can not only hold your hand during a market down phase; your advisor can also help you create a written plan that details your important financial goals, which can become your road map to follow. "We are all human beings, and fear can get the better of us. The best inoculation against a fear-driven investment mistake is professional guidance and a good plan," said Hamilton. For some investors in a downturn, “the discipline to rebalance, and to buy stocks at lower cost, is key.”
3. Tune out. This is not the time to be glued to the financial networks. Media reports can feed psychological frenzy, fear, and the feeling that an investor needs to do something now. For some, it makes the most sense to keep retirement portfolio assets sealed up on a real-time basis and instead wait for that quarterly statement. Long-term investors can shift their focus to what they can control, which includes the amount they can save and invest on a regular basis.
4. Consider your options. Some investors consider long put options on either the individual stocks owned or a general market index such as the Standard & Poor’s 500 Index (SPX). "Puts will increase in value [minus transaction costs] as the market declines, therefore providing a degree of price protection for the stocks remaining in your portfolio," says Dr. Gary Dayton, trader and founder of Trading Psychology Edge.
5. Craft your wish list. During rising market periods, research and develop a buy list of companies you would like to purchase on a market decline. When the market decline ends, you may have the opportunity to scoop up stocks you've been considering at bargain prices.
Fair Weather Research
Use our Stock Screener to prep for market down moves. Log in at tdameritrade.com > Research & Ideas > Screeners > Stocks. Then select the criteria that are important to you.