What To Do When The Stock Market Plunges


What To Do When The Stock Market Plunges

Fear and greed drive the stock market. Or as famed investor Benjamin Graham noted, in the short-term the market is a voting machine, but in the long-term, it’s a weighing machine.

When the Coronavirus was spreading in early 2020 votes were to sell, which caused the market to tank by about 12% from their all-time highs just days before! It was the largest drop since 2008; giving up all the recent market gains from the past 6 months. All in just a week. Ouch! It was quite scary.

Let’s take a quick step back and get some real world perspective. Let’s look into the past and talk about how other epidemics have affected the market in the long run.

Past epidemics have had little to no long-term impact on the stock market, even after a sharp drop. For example, in the 12 months after SARS, the market was up 21%. After a more recent epidemic, ZIKA, it was up 17%.

MARKETS DROP ON UNCERTAINTY

What the market hates most is uncertainty. The media and others play up the uncertainty to stir up fear for ratings. Epidemics and pandemics are serious and can’t be shrugged off.

It’s not known when they break exactly how bad these events will be, but we can be pretty confident they won’t be as bad as the media says.

That’s because the media outlets always talk-up the worst-case scenarios in order to strike fear, anger, and worry into the public so they will continue to tune in and check for updates.

The media uses what’s called open loops. Viewers want to find closure so continuing to monitor the situations by coming back works.

One thing that was different for the Coronavirus was that China made up a larger portion of the world economy as it had in the past.

But isn’t that always the story? That time it was different? Not so.

One thing I’ve learned from living through many dips, recessions, booms, and crashes is that it’s never different. It’s the same old story.

“The four most dangerous words in investing are: This time it’s different.” – Sir John Templeton

Shortly after the drop caused by Coronavirus, Warren Buffett, Jim Cramer, and other investors said that it was a buying opportunity. Why would they say that when the media is freaking out?

Because they know markets have historically rebounded within a month after big drops due to past similar uncertainties. They are experienced enough to know to take a long-term view of performance.

Be Motivated When The Market Falls

When the market falls, it is actually a time to be thrilled. Be happy because it means you can buy stocks at a cheaper price and accumulate more shares. No matter what phase of investing you’re currently in, you want to get as many shares as possible before they go up.

For those stock market traders in a phase who don’t need the money to live on and are putting money into investments, it benefits you to have a bear market for as long as possible, followed by a bull market just before your retirement.

Keep in mind it won’t work out perfectly, just be content when it goes down occasionally so you can get more shares and build a stronger position every month.

What Makes Stocks Fall?

The price of a stock is based on the net present value of all its future earnings. When investors think earnings will be high in the future, the stock goes up. When they think earnings will go down, the stock goes down. That’s a pretty simplistic view, but the main premise of how it works.

When the market suddenly drops, which we experience periodically and through the Coronavirus, it’s important to keep in mind it is driven mostly by perception.

In this case the perception and forecasts that earnings will go down. Part of that perception is always based on fear. Fear and uncertainty that things will get even worse in the future days, weeks, and months.

To be honest, earnings may not change significantly in a short period of time, but investors fear that they might. When stocks plunged thanks for the Coronavirus, it was due to the fact that investors feared it would disrupt the supply chain and cause companies to earn less money.

Pandemics can certainly change earnings and the Coronavirus did undoubtedly affected earnings, however it was not by much. In fact it was only 12% in a few days.

Apple closed it’s Chinese plants only to reopen them soon afterwards. It always turns out the fear is unfounded. No one is certain with all the media hype and pressure, and so they sell. That’s a huge mistake to make for the average investor.

DOLLAR-COST AVERAGE

Studies have shown that the best way to build wealth over time is to use the dollar-cost average formula.

This means you consistently invest whether the market goes up or down. It doesn’t make much difference over time if you try to buy at the bottom, or if you sell at the top.

This is because it’s so difficult to know where the top or bottom actually is. Another reason is partly because since you’re buying consistently, it will even out or average out.

There is an old quote that’s been passed down that says, time in the market is more important than timing the market.

The best thing you can do is to continue to max out your 401k and Roth IRA while focusing on paying off all consumer debt.

Continue to have contributions taken out of every paycheck and forget about it. Check back in 10 years and you’ll be pretty happy with what you see.

Diversify

Go now and look at your asset allocation and make sure you’re comfortable with it. It helps to have non-correlated assets, like stocks and gold or even better, a job or business that brings income that’s not related to anything. More on that in a second.

If you’re not comfortable with volatility or big drops, then consider diversifying into other asset classes like real estate.

KEEP A LONG-TERM PERSPECTIVE

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Continue to keep in mind stocks fluctuate and there’s always some other crisis right around the corner. The financial media outlets on TV are always predicting the next market crash. Remember they will eventually be correct because stocks continually correct and then move higher.

Warren Buffett said we’d all be better off if the price of stocks were only quoted once a year rather than every minute of the day. This is because the value of the underlying businesses change much slower than most people are aware of.

It matters very little how much stocks go up or down on a daily basis. That’s easy to forget when you lose 12% of your portfolio in a single week. The main thing is remembering to keep a long-term perspective. That will help us all sleep better at night. It’s why you should feel at peace knowing that every week you’re buying a little bit more of the global economy as it stretches along to greater heights.

What Should You Do Now?

Most people lose money in the market because they get spooked when it goes down and as a result they sell. The investors who sold in 2008 are kicking themselves after witnessing the market rebound, followed by an 11-year bull market that has seen the market tripled in value.

If you are wanting to secure your money and are tired of relying on market data and watching the panic reports then…

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Martin Hamilton

Martin Hamilton is the founder of Guiding Cents. Martin is an Author, Entrepreneur, Marketer, Financial Researcher & Investor. He is a long time Mortgage Planning Consultant & Licensed Real Estate Agent.

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