By Jessica Wee
We have all been there. Keeping calm when you watch the markets tumble resulting in your tumbling investment portfolio is easier said than done. It’s worse when faced with non-investing friends/relatives proudly displaying their ‘I told you so” facial expressions. It is as much a mental torture as it is a financial disaster.
While a market correction is impossible to predict, there are various strategies that we can deploy to minimize its impact on our investment portfolio.
- Never panic sell
During market corrections, selling off your investments might seem like a good idea (with the only exception being that you really need the money!). Negative news such as a pandemic, an asset bubble that’s about to burst, scams being revealed, etc., can influence any investor.
However, historical data shows there’s an average of one double-digit decline in the S&P 500 every 1.85 years. Even though the market doesn’t follow averages, it’s a good reminder of just how common lower market moves are.
The most noteworthy is the length of most corrections. Since 1950, only 7 of the previous 38 corrections (we don’t know precisely how long the current correction will last) have taken more than a year to find their bottoms. Comparatively, 24 of these 38 double-digit declines found their troughs in 104 or fewer calendar days (about 3.5 months).
As a whole, the S&P 500 spent 7,168 days correcting from peak to trough in the 72 years from Jan. 1, 1950 to Dec. 31, 2021. This works out to an average correction length of 188.6 days, or about six months.
Rebalance your portfolio
Portfolio rebalancing is a strategy that helps in reducing the overall risk in your investment portfolio to provide better risk-adjusted returns on your investments. This strategy involves buying and selling investments periodically so that the weight of each asset class is maintained as per your targeted allocation.
So, the first step in rebalancing your portfolio is to have an asset allocation strategy in place. If you don’t have an asset allocation plan in place already, a stock market crash offers you the perfect opportunity to take stock of your current investments. Some key factors to consider when assessing your current investments are:
- What am I invested in – Unit Trust/Mutual Funds, Stocks, Bonds, Gold, etc.
- What is the value of my investments?
- What are my financial goals?
- What do I focus on when building my investment portfolio – consistent returns, growth of capital, etc.
Once you have answered these questions and have a target allocation in place for different asset classes, you can accurately figure out your current situation. Then you can decide which investments you need to buy or sell to reach your asset allocation target.
If done right, rebalancing your portfolio will not only help you stay on course to reach your financial goals but also help manage overall portfolio risk when markets are volatile. That said, it might not be a good idea to rebalance your portfolio in the middle of a stock market crash. You should instead consider letting markets settle down a bit before rebalancing your investment portfolio.
Protect Your Personal Finances
A stock market crash impacts a lot more than just the value of your investment portfolio. In fact, financial markets can also affect employment, the Real Estate Market, consumption of goods, inflation, and much more. Thus stock market turmoil can have a different impact on different individuals, but there are a few things that you can do to minimize this impact.
Create a personal cash flow statement
A cash flow statement is a record of all the money that is coming in and going out on a daily basis. By maintaining a personal cash flow statement, you can organize your finances better so that a stock market crash does not impact your ability to take on essential expenses such as utility bills, rent, tuition fees, etc. Moreover, accurately tracking your expenses can also help reduce extravagant and often unnecessary expenses such as expensive dinners, unused gym memberships, spa treatments, streaming subscriptions, etc.
Create or top up your emergency fund
If you do not already have an emergency fund (6 months worth of expenses at least), now is a time to start! If you have an emergency fund already, a stock market crash is an ideal trigger to consider topping up the fund with an additional amount of up to 2 to 3 months’ expenses.
Manage your debt situation
As a rule of thumb, a stock market crash is not the best time for taking on additional debt. If you do so, you run the risk of becoming caught in a critical economic situation. Moreover, a correction in markets might also be an excellent time to refinance existing debt such as a Home Loan, Personal Loan, or Credit Card, especially if you have a good credit score.
Invest in carefully researched equities aka quality buys
While Equities are cheaper when stock markets tank, it is essential to be careful when making these investments. A stock market crash provides you the perfect opportunity to increase your equity allocation at a reasonable cost and allows you to switch to a more aggressive asset allocation from a comparatively conservative allocation. This is because equity investments, especially when purchased at low valuations, have an unmatched ability to boost your investment returns for long-term goals such as retirement.
You can also consider purchasing equity Unit Trust/Mutual Funds and stocks when valuations are low during a market crash. That way, you might be able to generate significantly high returns when markets recover at a later date. For example, if you consider the broad-based S&P 500 Index, you will see that this index has gone up by 75% in the previous year, which is substantial. But you must make sure you do sufficient research when selecting individual stocks to invest in.
This is because, when markets recover from a crash, not all stocks give good returns. So, if you plan to make equity investments during a market correction, make sure you do adequate research. But, if you do not know how to value stocks or don’t have the time to research investment options, it might be a better idea to invest in professionally managed diversified Equity Unit trust/Mutual Funds as compared to investing in individual stocks.
Focus on making long term investments
When stock markets tank, a few questions come up every time – Will the stock market go down to zero? Will the economy recover? Can stock prices increase from here? Is the valuation cheap for a reason?
Every time the answers are the same – the stock market does not go down to zero, the economy always recovers, and stock prices go up, reaching new all-time highs, some companies Do remain cheap for a reason!
While short-term volatility is inevitable when you are investing in equities, how this volatility affects you depends solely on you. If you are investing for the long-term, these ups and downs in the stock market should not bother you.
So if you are investing for the long-term, you should keep a level head and not pay too much attention to market movements. Instead, focus on your behavior by doing the following:
- Resist the urge to engage in panic buying and selling
- Make sure your portfolio is rebalanced
- Protect your cash flows and stay employed
- Understand that volatility is an integral part of the investment process, and there will be many more market corrections in the future
As it was famously quoted by Abraham Lincoln – this too shall pass!