How do you respond when things look a little crazy on the stock market? Should you sell your stocks and go to cash during volatile markets, or should you stay the course, and keep your money invested for the long haul?
One of the most common responses is to get worried and sell, deciding to go to cash. According to T. Rowe Price, that can be costly in the long run. While it might be hard to hang in there when you see your portfolio drop in value, for many long-term investors, it’s best to turn off your emotions and stick with your investing strategy.
When you see several days of steep losses in a short period of time, it can be tempting to switch into panic mode, following the crowd and dumping your stocks. However, panic selling can cause you bigger problems in the long run. Consider that one of the biggest factors in your success as an investor, as well as in other areas of life, is your mindset. Are you letting fear cloud your financial judgment? If so, you could miss out on some of the opportunities provided by a down market.
One of the worst things you can do during times of market volatility is panic. Decisions based on a knee-jerk reaction are usually bad decisions — especially if it means dumping a fundamentally sound stock and locking in your losses. Before you sell due to a market drop, imagine the words “don’t panic” in large friendly letters 😉 Step back and think about why you want to sell. If you want to sell because everyone else is selling, it might be time to adjust your mindset and start looking for opportunities.
Fear-Driven Finances and Loss
The stock market is an oft-cited example of what can go wrong when you let fear rule your financial decisions. During the financial crisis of 2008, and in the aftermath, a number of people, afraid of the stock market’s poor performance, sold. The problem when you sell at a time like that, of course, is that you end up locking in your losses. I was a little bit afraid for some of my investments, but I ignored my panic reaction and kept with my dollar cost averaging plan. Now, I’m seeing better returns.
Of course, there are other ways to let fear rule your finances. Some of these fears include:
- Fear of missing out: Many people are driven to scams because they are worried of “missing” a big opportunity. Pressure to get in, or you will miss out, can work on a different type of fear that pushes you into poor decisions.
- Fear of falling behind: Do you look at your friends and family and worry that you are falling behind? This type of fear can prompt you to spend beyond your means. Your fear of how you look in front of others might result in debt that can get out of hand.
- Fear of risk: While you don’t want to take irresponsible risks, you shouldn’t shun risk altogether. Some risks are smarter than others. You need to add a little risk in order to be successful, whether it’s investing in a carefully considered ETF or starting your own business. Here is more on risk tolerance and investing.
Don’t Let Fear Rule You
You don’t want to let fear rule your financial decisions. That means that you need to take steps to protect yourself from yourself. In many cases, you can stop fear from taking control by refusing to make quick decisions. Rather than selling everything all at once, ask yourself what’s changed. If the fundamentals of an investment are the same, there is a good chance that it will recover with the rest of the market. Realize, too, that great “insider” opportunities are meant to use fear to push you into making an irrational decision. Think it over carefully. Most legitimate opportunities don’t expire immediately.
Stepping back can also help you avoid making other financial mistakes. Ask yourself why you are doing something. Honestly answer why you want to buy a new car, new shoes or a bigger TV. Learn to be comfortable with your own expenditures and lifestyle, and do your best to stop worrying about other people have. If you focus on what you are grateful to have, you will feel less fear about keeping up with your neighbors.
It can be hard to overcome your fears, even the fear of money. However, if you study your own emotions, and refuse to make financial decisions when fear is the dominating stimulus, you can reduce the number of poor choices you make. Education can help, too. Learn about yourself, and about how money makes. You will feel better about your decisions when they come from knowledge, rather than from fear.
Stick to Your Long Term Plan
Now is not the time to abandon your long-term plan. If you have made an investing plan, stick with it — especially if you have a couple decades left before its fruition. When you have a solid investment plan, it is likely to bear you out over the long term. Short term, things can look pretty jagged and volatile. However, if you look at market movements over a period of decades, things tend to smooth out. Long-term, there is a great deal less volatility. This is good news for your long term investing plan. Don’t let today’s fear keep you from reaching your ultimate investing and financial goals.
While this might be a good time to re-evaluate where you stand, and to diagnose some weaknesses in your portfolio or asset allocation, it’s not the time to change everything up just because you’re afraid. Take a measured approach to tweaking your plan, but don’t scrap it completely.
Deciding to Go To Cash When Markets Drop Can Cost You
The biggest problem with selling when you get worried is the fact that you are essentially “locking in” your losses. Until you actually liquidate your stocks, your losses are pretty much just on paper. They don’t become “real” until you sell. Essentially, when you sell during a market downturn, you are selling low after you have bought at a higher price.
You will also see other costs when you go to cash during a downturn. Not only do you lock in current losses, but you also run the risk of losing out on bigger future gains.
I use a dollar-cost averaging strategy with my long-term investing. I invest the same amount of money each month, no matter what’s happening with the market. This means that when the market is lower, I essentially end up buying my investments “on sale.” During a market recovery, that means that my portfolio grows at a faster rate than someone who has been growing a cash account, and finally decides to get back in after prices have begun rising again.
The T. Rowe Price article includes an illustration of two investors who set aside $2,000 each quarter from the beginning of 2001 through the end of 2015. One investor sells and goes to cash when the market drops by 10% or more in a quarter, and then doesn’t get back in until there are four quarters in a row of positive returns. The other investor just plugs away, putting that money into stocks, no matter what is going on. By the end of the exercise, the investor that goes to cash has less than half the account balance as the investor that was able to take advantage of low prices and bigger returns.
This illustrates how deciding to go to cash can cause problems, especially if you do so after the big market drop. While some of this can be mitigated if you sell and switch to cash before a market drop, the reality is that few of us are good at timing the market in this way.
Using Asset Allocation to Improve Your Peace of Mind
This doesn’t mean that there is no place for cash in your investment portfolio. The danger comes in making big changes to your portfolio during times of market turmoil. Instead, it can make sense to use asset allocation to your advantage over the long haul.
You can create a portfolio that includes cash and bonds (and maybe other assets, depending on your goals and risk profile) in addition to stocks. It might help you sleep better at night knowing that you portfolio is 70% stocks, 20% bonds, and 10% cash. In some cases, you might even tweak those numbers, depending on where you stand with your financial goals and risk tolerance.
The idea is that you can consistently invest in those set proportions, occasionally rebalancing as you see drift in your asset allocation. With this method, you can use index funds or ETFs to help you manage your investments, rather than worrying about stock picking. It’s one way to reduce some of the risk and increase the chances that you will come out ahead in the long run.
Carefully consider your situation and what makes sense for you. However, be aware that most ordinary investors don’t do well with stock picking. Also keep in mind that, often, the very worst time to sell your stocks and go to cash is when everyone else is panicking and doing the same thing.
Look for Opportunities
Now might be time to look for opportunities. Cheap stocks abound during times of stock market volatility and times of economic recession. You could pad your retirement account, or enhance your income portfolio. Even beginning investors can benefit by investing in index investments that have a little less risk than some other individual investments.
If you are a little more advanced as an investor, you can look for other opportunities. It might be a good time to buy precious metals, before they skyrocket higher. (Some think that now might be a good time for silver, especially if gold is to rich for your blood right now.) You might also find interesting opportunities in currencies, or other investments. Times when the real estate market is doing poorly might produce opportunities for you to buy cheap property to hold on to for a time. During the last economic recession, freelancers were able to find a number of opportunities as companies looked for skilled workers with lower overhead.
Instead of dwelling on how horrible everything is, you can be on the look out for opportunities in times of market and economic uncertainty.