I’ve written a few articles recently about the start of the year stock market freak out and about not panicking when the stock market makes sudden moves. In response I’ve heard from people about if there ever is a time to panic, and if there isn’t, if there is ever a right time to sell. The problem is that there is some knowledge missing from these questions. So, here is a reality check on the current stock market situation, and some advice on when to panic and when to sell your stocks.
Long-Term Diversified Portfolio
Let’s start from the beginning. There are a lot of different kinds of investing. When people forget this fact, it often causes them to make incorrect decisions. Remember, every decision you make should be consistent with your investing strategy and financial plan.
So, for those of you investing for the long-term, particularly for retirement, with a decade or more to go, your reactions should be very different from someone who is investing for other reasons, or for a shorter time frame. As a long-term retirement investor, your strategy should be to construct a well diversified portfolio that matches your return needs with your risk tolerance. Unless you have $250,000 or more in that portfolio, chances are the best securities for you are mutual funds, index funds, or exchange traded funds (ETFs). In this case, you will not own any individual stocks.
If this is how your investment strategy looks, then you should pay no attention whatsoever to the daily news and stock market fluctuations. I know this sounds counter-intuitive sometimes, but it is completely true. The entire point of this investment strategy is to deliver returns over a long period of time. It will do so, as long as you leave it alone and let it. The failure of this strategy is virtually always user error. Losing faith and selling (usually after a market downturn, which means selling low) and then coming back to this strategy later (usually after the market recovers, which means buying high) is how you fail. Leaving your investments alone, and continuing to invest regularly and consistently is how you win.
To put it another way, do you think the stock market will be down in 10 years (that’s 2026) because of China, or cheap oil?
Shorter-Term Diversified Portfolio
Now, what if you are investing for something a little shorter term?
Here is where we as Americans sometimes have a very nasty disconnect with reality. The above strategy of investing in a diversified portfolio and rebalancing it on a regular basis has a pretty much perfect track record over 10+ year periods. However, as you can see from any 10 year chart, that track record is not so good over shorter time periods.
Above is a 10-year chart of the SP 500 up to January 24, 2016. You’ll notice some things. First, off, if you happened to invest at the peak before the Great Recession, it would have taken you nearly 5 1/2 years to recover all of your losses in the S&P 500 index. That sounds bad, but even then, notice that over the full 10 years you are still very comfortably up in that investment. If you invested at any time, but the peak, your profits are even greater. If you were smart enough to KEEP INVESTING during that really nasty downturn, the investments made during that time are way up. Now remember, an actual diversified portfolio wouldn’t be all in the SP500 (which is just large U.S. stocks) and you would have even better returns, with shallower drops.
But, imagine that in 2008, you invested $25,000 in a 529 college savings plan for your 15 year old. That has a very different ending doesn’t it? That’s because a three or four year time frame is too short for investing in the stock market. If you need your money in 3 years or less, you need to think bank, or maybe bonds, but even then, you need to be conservative. The stock market is for the long-term, not for the short-term.
Speculation and Individual Stock Buying
Now, let’s say you are doing well with your financial plan. Let’s say your 401k is maxed out, and you are on target for your retirement. Let’s say that your kids have full, plump 529 plan investments, and that you have a nice cushion of savings for an emergency reserve fund. If all of those things are true AND you have at least six-figures sitting in a brokerage account, we can talk about a little speculation, or individual stock picking. The reality is that the deck is stacked against the average investor, but I won’t tell you what to do with your own money.
In this case, can you worry a little bit about this current market downturn?
Yes, but again, this is all about strategy.
Is your strategy to buy stocks for the short-term? If so, you should already have some sort of buy and sell strategy before you buy your first stock, and you should know how you plan to react to bad news. (This isn’t generally profitable for anyone but full-time traders, and frankly the returns are more often luck than skill.)
If your strategy is to buy good companies that you think are growing, or to buy solid companies that pay dividends, then the question is, has your analysis of that company changed? If not, you would be a fool to react to news that has nothing to do with your actual investments.
Never forget that most volume on any given day in the stock market is computers trading against computers. In other words, this isn’t necessarily thousands of Apple shareholders throwing in the towel and selling their shares, this is Computer Tradign System X381 at Super Bank selling based on model Z994 because of volatility in China without a corresponding drop in the Euro.
Also, remember, most experts believed the stock market went too high, too fast in the first place. Look at that chart above again. From 2013 to 2016 is almost straight up. That’s not how things typically work, unless the economy is roaring along, and this economy is puttering along. In fact, a line from 2013 to where markets are even with this recent downturn has a pretty steep slope. Stocks would seem to be less losing money right now, than they are giving back prices they never should have attained in the first place. Again, check your strategy, not the news.
If you think your stock can’t handle economic turmoil in China, then it probably isn’t a very good investment right now. On the other hand, if you think your stock will continue to grow and pay solid dividends regardless of what happens in China, then your strategy hasn’t changed.
Remember smart investors act when their strategy is no longer valid, not when the news changes.
This article is for general informational purposes only. It is not a recommendation to buy, or sell securities. It is not investment advice. Consult your finance or tax professionals for specific advice regarding your individual situation.