Part of Keil Financial Partners’ five step retirement revelation process focuses on investments and setting them up in a way that will allow you to reach your ideal retirement. While it’s easy to manage your investments and talk about rebalancing and diversifying when the markets are going up, what happens when the markets drop like they have recently?
We know it can be difficult to think about and manage your investments when you’re in the thick of a market drop, and that’s why we’re here today to guide you through what to do when the market drops.
Here are 4 things to do when the market drops.
Understand your emotions, and pause before acting
Emotional reactions to dips in the stock markets are natural. There’s nothing wrong with feeling emotions when you see your investments go down. But that’s also why it's so important to work with an advisor who can walk you through the numbers and remind you of your long-term plan and goals to keep you on-track.
It might also be helpful to take a step away from the news to help you maintain perspective. There have been several studies that have shown that people who look at their investments less frequently have actually ended up making more money because they looked at things with a broader time horizon. Plus, this also gave them a better perspective on things that might seem scary within one particular moment.
If you take a few more moments in between your reaction to the markets going up and down, rather than taking immediate action, you’ll likely make a much better decision. Write down what you would like to do with your investments. And write down the best and worst case scenarios for both taking the action, and not taking the action. Wait a day and take a look at your list to see how you still feel about it, before action. Or better yet, run it by a financial advisor who can talk you through the options and may have a better sense of what those best options might be for you.
Re-Assess Your Risk Tolerance
When the market drops, the first thing we encourage you to think about is your risk. Both how much risk you are willing to take, as well as how much risk you are able to take.
Your risk tolerance is all about how much risk you are willing to put up with, and when the market goes down like it has lately, your tolerance will truly be put to the test.
We suggest that when the market is down, write down some of your thoughts. What are you feeling right now when the markets are down? What are you doing right now regarding your investments? This will help you later when the markets come back up (and they will come back up!) to gauge your true risk tolerance.
One way we like to measure risk tolerance with clients is to ask a few different questions. For example, on a scale of one to 10, how much risk are you willing to put up with in the market, with 10 being the highest level or risk? Or, if you don’t want to think in terms of numbers, ask yourself: Do you want to have average risk, above average risk, or below average risk?
Make sure your advisor knows how much risk you want to take, and make sure you know how much risk you are actually taking. We’ve met plenty of people that tell us they want to be conservative but it turns out they are almost 100% in the stock market. “But my advisor says these are conservative stocks!” they say. Sorry to say this, but there is no such thing as a safe stock. Conservative does NOT mean ‘100% stocks, but they are ‘good, conservative’ stocks.
Another thing to consider is when you need the money that you have in the market. While most of our clients are well prepared and understanding of how the market works, there are still some that need extra reassurance around what to do when the market drops. That’s when we ask: When do you need the money? Chances are, it’s going to be a while before you need it — what do you think the markets will do in the meantime by the time you need it? If you set things up properly, it might be years before you need a dollar that you have in the stock market, so why do you feel like you need to pull money out of the stock market today that you don’t need it yet?
And remember, don’t be tempted to try and time the market. By doing that, you have to get the right timing twice. You have to time the market and know when to get out, but also when to get back in. If you get back into the market after it goes up 30%, you’re not doing yourself much good. Instead, make sure you have some short-term money and some long-term money and let your long term market money rebalance and come back up again.
Diversify Your Investments
Diversification is about not having too many eggs in one basket and instead spreading them out to a bunch of different areas. To do that, you have to have the right level of stocks and the right level of bonds. You also have to have some short-term money and some long-term money.
When diversifying your investments, think of what might come up over the next few years that you might need money for. That’s the money that should likely be out of the market. On the other hand, money that you have and won’t need for a few years can be in the market, but make sure you have the right level of risk.
An easy way to think about diversification is to revisit your risk tolerance on a scale of one to 10. If your risk tolerance number happens to be a six, then you could have about 60% of your investments in the stock market with the other 40% in other areas like bonds, cash, or other investments that won’t go down with the stock market.
Diversification can even help in times like these where the market drops because you’ll likely have a couple of investments that are up. That’s the whole point of diversification — not everything will be going up and down at the same time, and maybe the investments that didn’t do so well last year are doing well this year.
Rebalance Your Portfolio
When it comes to rebalancing, many people wonder when exactly they should be rebalancing their investments. However, many studies actually found that it almost doesn’t matter when you rebalance, it just matters that you actually do it.
At Keil Financial Partners, we like to look at when to rebalance by using tolerance bands. Tolerance bands is an idea that recognizes that if you set a level, or range, that you want your investments to be distributed in, when the markets go up and down, your investments may move out of that range.
For example: perhaps you want 20% in large company stocks, and you set a range of +/- 3 percentage points. If your amount of large company stocks falls to less than 17% or more than 23% then you don’t really have what you signed up for, do you?
When your investments are outside of the range you may have too much risk when the market is high, and not enough stocks when the market is low. Periodically look at rebalancing to get everything back in your desired range. Don’t wait for a specific day to rebalance. If nothing changes for six months, why bother rebalancing? Instead, if it takes 2 months, or two years for your investments to get out of the ranges, that could be a good time to rebalance and bring everything back to the level of risk you want.
(bonus) What to do if You Didn’t Plan Ahead for Market Drops
While we’d like everyone to have a plan that can help guide them through market drops, we know this isn’t the reality for everyone. So, if you didn’t have a plan before a market drop, but still need some money, what do you do?
The first thing we would encourage people to do is to meet with their advisor or financial professional, and to look through and see where else you might be able to get the money from before pulling your investments from the market.
One thing you could do is delay a big purchase depending on your priorities and what is truly needed at the time. This might also be a time to not spend as much so you don’t need to sell some of your stocks at a discounted rate.
A lot of the time, many people also don’t realize that their investments give out dividends and gains each year. Usually, the best idea is to reinvest it and buy more shares of the same investments, but if you really need money, perhaps look at taking those dividends and gains out of your investment accounts rather than selling stocks.
You might even be able to look around in your bank accounts and look at if you have the right amount of interest. Are you getting paid the best interest rate that’s out there? We just met somebody whose interest was incredibly low. Working together with them, they are going to start getting $1,000’s more each year in interest, without having to sell one stock.
No matter what you do during a market drop, we believe in keeping your long-term goals and plan in mind and to avoid acting based on emotion. If you need extra guidance, be sure to get in touch with a trusted financial professional who can help you based on your circumstances and needs.
If you have any additional questions about investing during times like these, please do not hesitate to reach out to us! We’re always happy to help in any way we can.