“This is a test; this is only a test. Had this been an actual emergency …”
The truth is, the markets are not tanking as I write this piece. In fact, overall market temperatures have been so mild for so long, many newer investors have yet to weather a perfect market storm. Even if you have, you may have forgotten how panic-inducing those times can be.
This worries me. Experience and evidence alike show us how severely bear markets test investor resolve, sabotage otherwise solid plans, and just plain hurt. We’ve also seen how damaging it can be to act on rash fear rather than rational resolve during market downturns.
So let’s pretend, shall we? Just as we prepare for other emergencies by practicing how to avoid deadly blunders in the heat of the moment, here are 10 timely actions you can take when financial markets are tanking … and, frankly, even when they’re not. Please respond to this email with any actions you think are missing from this list, I’d love to incorporate them into the list the next time there is a “test.”
1. Don’t panic (or pretend not to). It’s easy to believe you’re immune from panic when the financial sun is shining, but it’s hard to avoid indulging in it during a crisis. If you’re entertaining seemingly logical excuses to bail out during a steep or sustained market downturn, remember: It’s highly likely your behavioral biases are doing the talking. Even if you only pretend to be calm, that’s fine, as long as it prevents you from acting on your fears.
2. Redirect your energy. No matter how logical it may be to sit on your hands during market downturns, your “fight or flight” instincts can trick you into acting anyway. Fortunately, there are productive moves you can make instead – such as all 10 actions here – to satisfy the itch to act without overhauling your investments at potentially the worst possible time.
3. Remember the evidence. One way to ignore your self-doubts during market crises is to heed what decades of practical and academic evidence have taught us about investing: Capital markets’ long-term trajectories have been upward. Thus, if you sell when markets are down, you’re far more likely to lock in permanent losses than come out ahead.
4. Manage your exposure to breaking news. There’s a difference between following current events versus fixating on them. In today’s multitasking, multimedia world, it’s easier than ever to be inundated by late-breaking news. When you become mired in the minutiae, it’s hard to retain your long-term perspective.
5. Revisit your carefully crafted investment plans (or make some). Even if you yearn to go by gut feel during a financial crisis, remember: You promised yourself you wouldn’t do that. When did you promise? When you planned your personalized investment portfolio, carefully allocated to various sources of expected returns, globally diversified to dampen the risks involved, and sensibly executed with low-cost funds managed in an evidence-based manner. What if you’ve not yet made these sorts of plans or established this kind of portfolio? Then these are actions we encourage you to take at your earliest convenience.
6. Reconsider your risk tolerance (but don’t act on it just yet). When you craft a personalized investment portfolio, you also commit to accepting a measure of market risk in exchange for those expected market returns. Unfortunately, during quiet times, it’s easy to overestimate how much risk you can stomach. If you discover you’re miserable to the point of breaking during even modest market declines, you may need to re-think your investment plans. Start planning for prudent portfolio adjustments, preferably working with an objective advisor to help you implement them judiciously over time.
7. Double down on your risk exposure – if you’re able. If, on the other hand, you discover you’ve got nerves of steel, market downturns can be opportunities to buy more of the depressed (low-price) holdings that fit into your long-range investment plan. You can do this with new money, or by rebalancing what you’ve got (selling appreciated assets to buy the underdogs). This is not for the timid! You’re buying holdings other investors are fleeing in droves. But if you’re able to do this and hold tight, you’re especially well-positioned to make the most of the expected recovery. Our clients know that we do this systematically however please feel free to call me with any questions about rebalancing.
8. Tax-loss harvest. Depending on market conditions as well as your own circumstances, you may be able to use tax-loss harvesting to turn financial lemons into lemonade during market downturns. A successful tax-loss harvest lowers your tax bill without substantially altering or impacting your long-term investment outcomes. This action is not without its tricks and traps, however, so it’s best done in alliance with a financial professional who is well-versed in navigating the challenges involved.
10. Talk to us. We don’t know when. We don’t know how severe it will be, or how long it will last. But sooner or later, we expect the markets will tank again for a while, just as we also expect they’ll eventually recover and continue upward. We hope today’s drill will help you be better prepared for “next time.” I also hope you’ll be in touch if we can help. After all, there’s never a bad time to receive good advice.
“In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, ‘This too will pass.’ Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.”
– Benjamin Graham, economist, “father of value investing”
Have a relaxed weekend,