What to do when the stock market drops?

Seeing the stock market decline can be unsettling, but it’s a normal part of the economic cycle. Market downturns, often referred to as market corrections or even bear markets, can be triggered by various factors. Understanding these reasons can help you stay calm and make informed decisions. Some common causes include:

• Economic Slowdown: Concerns about a recession, rising unemployment, or slowing economic growth can lead investors to sell stocks.
• Geopolitical Events: Global uncertainties like wars, political instability, or trade disputes can create market volatility.
• Interest Rate Hikes: When central banks raise interest rates to combat inflation, it can make borrowing more expensive for companies and consumers, potentially impacting stock prices.
• Company-Specific Issues: Negative news or poor performance from major companies can sometimes trigger broader market declines.
• Investor Sentiment: Fear and panic can become contagious, leading to widespread selling pressure, even without a clear fundamental trigger.

The Investor’s First Reaction: Why Panic Selling Can Be a Mistake

When the market drops, the natural human instinct is often to panic and sell your investments to avoid further losses. However, panic selling can be one of the biggest mistakes an investor can make. Here’s why:

• Locking in Losses: Selling when prices are low means you’re essentially solidifying your losses. You’re buying high and selling low, which is the opposite of successful investing.
• Missing the Rebound: Historically, the stock market has always recovered from downturns. By selling, you risk missing out on the eventual rebound and potential gains.
• Emotional Decision-Making: Panic selling is driven by emotion rather than a rational assessment of your long-term investment goals and the underlying fundamentals of your investments.

Smart Strategies: What to Do When the Market Takes a Dip

Instead of panicking, consider these more strategic approaches when the stock market declines:

1. Stay Calm and Don’t React Impulsively: The most important thing is to remain calm and avoid making rash decisions based on short-term market movements. Remember your long-term investment plan.
2. Review Your Investment Portfolio: Take this opportunity to review your asset allocation. Ensure it still aligns with your risk tolerance and long-term financial goals.
3. Consider Dollar-Cost Averaging: If you have regular contributions to your investment accounts, continue with your plan. This strategy, known as dollar-cost averaging, involves investing a fixed amount of money at regular intervals, regardless of market¹ fluctuations. When prices are lower, you buy more shares.
4. Look for Potential Buying Opportunities: For long-term investors with a higher risk tolerance, market downturns can present opportunities to buy quality stocks at discounted prices. However, do thorough research before making any new investments.
5. Rebalance Your Portfolio (If Necessary): If your portfolio’s asset allocation has drifted significantly due to market movements, consider rebalancing to bring it back in line with your target allocation. This involves selling some assets that have performed well and buying those that have underperformed.
6. Focus on the Long Term: Remember that investing is a marathon, not a sprint. Market downturns are temporary, while the potential for long-term growth remains.
7. Don’t Try to Time the Market: Predicting when the market will bottom out is virtually impossible. Focus on your long-term strategy rather than trying to time your entry and exit points.

Understanding Your Risk Tolerance During Market Volatility

A market downturn is a good test of your risk tolerance. If you find yourself extremely anxious and tempted to sell everything, it might indicate that your current portfolio allocation is too aggressive for your comfort level. Consider adjusting your portfolio to include a greater proportion of less volatile assets, such as bonds, in the future.

Historical Perspective: Market Downturns are Part of the Cycle

Looking back at the history of the stock market, you’ll see numerous periods of decline followed by eventual recoveries and periods of growth. Understanding that market downturns are a normal and recurring part of the economic cycle can help you maintain a long-term perspective and avoid making emotional decisions.

Navigating Market Drops with Confidence

While a falling stock market can be concerning, it doesn’t have to derail your long-term financial goals. By understanding the reasons behind market downturns, avoiding panic selling, and implementing smart strategies, you can navigate these periods with greater confidence and potentially even find opportunities for future growth. Remember to stay informed, focus on your long-term plan, and consult with a financial advisor if you have specific concerns about your investments.