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5 Things NOT to Do in a Down Market

There’s no denying it: last week was a doozy.

Last Wednesday, the Dow took its deepest dive of the year to date, dropping more than 3% mid-day, then bouncing back to close down “only” 1.4% at 15,767. For those of us who have gotten used to seeing Dow numbers in the high 17,000s, we got flashbacks to 2008 when the market went into a freefall. This has been the worst start of a new year ever.

The good news is that we are, in no way whatsoever, in the same climate as in 2008. As I’ve said before, while there are numerous factors impacting the market at the moment, the problem is not the US economy. And while that may not make the numbers feel any better, it does mean that we’re most likely facing a short-term down market—the industry refers to it as a “correction” if it’s around 10% or so. But as long as the US economy continues on its upward trend, most forecasts point to a full recovery. The question, of course, is “when?”

The answer is simple: No one knows. With that in mind, it’s important to remember that making a wrong move at the wrong time can do much more harm to your portfolio than any market downswing. Here are 5 things not to do to be sure you maximize the situation while keeping your risk as low as possible:

1. Don’t doubt your portfolio.

Assuming you’re working with a knowledgeable financial advisor, your portfolio should already be balanced to absorb a certain level of risk depending on your time horizon. Most of my clients are either nearing or already in retirement, so our portfolios include an average of 40-42% stocks. This means that around 60% of each portfolio is already positioned to downplay market risk. And if you do second-guess your strategy, where would you go? All the alternatives present challenges of their own. Gold is a losing proposition (read my July blog Forget the "proven" path to success and stick to the basics to learn more). Hedge funds and commodities aren’t any safer than stocks. And stuffing cash under your mattress stops future earnings in their tracks. Trust the decisions you made when the market was rising—they’re just as good today as they were last July.

2. Don’t think short term.

Unless you’re a day trader (which I do not recommend!), your focus should be on the long term. And when looking at the long-term outlook for the US economy, things are pretty darned bright. Last week, some investors panicked and shifted stocks into less volatile government bonds. There are two big issues with that strategy. First, “shifting” means selling, and by selling when the market was down, money was lost. Second, while that money is now in a “safer” place, there’s no chance to recover the loss. Shifting to bonds is a purely emotional move that doesn’t account for the fact that, inevitably, the market will rise again.

3. Don’t get hung up on China.

Yes, China has been dampening the US stock market. The lack of transparency by China’s government has scared investors who aren’t sure what to believe. As transparency increases (the shift has already begun), investors will feel more confident in the numbers, and the market should react positively. Adding to the fear factor are the misleading headlines about China. Sure, China’s economy is (as the media loves to shout) “the lowest it’s been in 25 years.” But when you consider that China was leading the entire world in growth for three decades, that claim is much less exciting. China’s economy has slowed because it’s in the midst of an economic transition, moving from a pure manufacturing model to a service model. In this scenario, earnings for established manufacturers slow, and it can take some time for the newer service-based businesses to flourish.

4. Don’t stop investing.

If you still have two or more years to go before retirement, now is the time to invest as much as you can into the market. Wall Street is having a fantastic sale! The S&P 500’s forward PE ratio stands at 14.9, its lowest since the first quarter of 2013 and well off the 17.4 level of last May when the stock market hit its record high. The recent year-over-year profit declines for the S&P 500 companies are expected to take until at least the second quarter of 2016 to improve. If that happens, then we’d have the rest of this first quarter to reposition assets to advantage.

5. Don’t forget to utilize other assets.

If you are retired and you’re already taking distributions from your portfolio, explore using other assets to cover your expenses. You’ll still have to take your required minimum distribution (RMD), but if you’re taking more than the minimum, see if you can cut back by leaning on non-stock assets such as savings accounts and CDs. The more you can keep in the market at the moment, the more opportunity you’ll have to recover from the downturn. Now may also be a good time to rethink large expenditures. My client Joe had two costly vacations planned in the next 12 months—a 2-week winter cruise that was going to cost $10,000, and a long-planned anniversary trip to Europe with his wife in August that will cost $15,000. Because Joe wants to cut back on his IRA withdrawals, he’s decided to forego the cruise. And maybe by August the market may be in recovery mode and he and his wife can head to Paris without a worry. C’est la vie.

We all know someone who made a bad choice in the past—either in 2008 or earlier—by reacting to the market numbers and acting out of fear, rather than looking at the situation from all angles and creating an appropriate, long-term strategy. One good friend of mine pulled all his money out of stocks until it was the “right time” to get back in. He’s still waiting. Another sold her home at the bottom of the housing crash, certain the market would never recover. She reinvested the cash in another house, has yet to recover the loss of more than $300,000, and has had to postpone her retirement as a result. Don’t be next year’s tale of woe: do what you can to take your emotions out of the picture, and don’t make mistakes that are sure to come back to haunt you when the market kicks back into the green.