Last fall, the stock market was highly volatile, with share prices shooting up and down. This year, this volatility turned into consistent loss, and the market was down substantially as of mid-February: Indeed, the Dow Jones Industrial Average was down nearly 13 percent from its record in May of last year.
Some pundits see this as a prelude to a bear market (defined as a 20 percent drop) while others say the overall decline will go no further than a correction (defined as a decline of at least 10 percent). As of Feb. 10, the S&P 500 was down for the year by 9 percent.
This is a sharp departure from the bull market that ran hard from 2009 through 2014, and a downturn from the market's more or less flat performance in 2015. Many investors regard the market's performance so far this year as bad news, yet they curiously act as though they'd never expected it to happen—despite common knowledge of the market's long history of doing just that.
This is simply what the stock market does. Ultimately, what goes up will come down. There's no such thing as an ever-ascending market. If there were, investing would be a sure thing.
Most investors who panic and sell when the market declines know this, of course, but they sell anyway. This panic stems from their failure to remember that previous declines, such as the deep one when the market melted down in 2008, will repeat themselves. How soon they forget, and how soon they get complacent and too comfortable in bull markets. This comfort can be a liability because it sets up undisciplined investors to overreact when things get rough.
Many investors see the market's current state as such bad news that they must do something about it. So, consumed by fear, they are compelled to sell their stock holdings, often for much less than they paid for them. This is all too common and all too misguided. And in this situation, they probably shouldn't do anything. That's right. The answer is: They should probably do nothing, leaving their investments alone and giving them a chance to rise in value.
Nothing is a tough thing for most people to do, but that's usually the best choice when the market declines, whether it's a precipitous decline or a herky-jerky one. But when the line on the graph is headed downward, it's tough to keep a level head and remember the wisdom of sticking to your plan.
This plan should constructively anticipate declines by calling for your portfolio's assets to be spread over different assets that don't tend to move in the same direction. For example, bonds have historically tended not to decline when stocks do, so bond holdings can usually buoy a portfolio's total value when stocks fall. Sure, you won't make as much money on stocks in good years if you've been parking money in bonds instead and bonds don't do well. But this portfolio diversification reduces risk, helping to protect you from big hits, likely increasing your long-term average returns.
This is a time-honored strategy used by wise, long-term investors, helping them make it to retirement with the least damage and, thus, better overall returns. Like these people, you should probably deal with these declines in advance by creating a sound plan for asset allocation that accounts for income, goals and risk tolerance. This plan for investing should be carefully assembled—like a blueprint for a house. And as with a house, the sounder the plan, the sounder the portfolio.
This takes a rare quality in any endeavor: discipline. You can't do anything about the market, but you can do something about yourself. If you don't have a plan, get one, and resolve to stick to it with discipline when the market tanks. This is the way to ride out market storms, avoiding panic and rash moves.
This content is based upon information believed to be accurate by ISI Financial Group, Inc. However, it should not be relied upon for legal or accounting purposes. You should always use the custodian's brokerage statements as an accurate reflection of your portfolio. Past performance is not indicative of future performance. Investments involve risk, including the possible loss of principal. Always seek professional advice before making any financial or legal decisions.