One of the scariest things about investing is when there’s a stock market drop. Although this is a very normal thing, many of us can’t stomach watching our money lose it’s value. We start to question ourselves; are we doing the right thing or is there something else we should be invested in?
This year was exceptionally painful. There was some huge gains at the start of the year, but the TSX (Canadian stock market) has dropped by 12% on the year. We’ve been so used to seeing big gains over the last few years that some us started to believe that things can only go up. In times like this it’s important to stay calm and focused – otherwise you risk making big mistakes.
These things don’t matter
Investors seem to have short memories, don’t forget about what happened to the stock market drop of 2008? There was a massive crash and people started to panic. Those who decided to pull their money out of the markets or to sit on the sidelines missed the huge gains that came the following years. When markets are down it’s a buying opportunity since stocks are basically on sale.
Wait what do I mean about it being on sale? Most people are emotional investors so when they see their investments going down in value, they in turn sell theirs which brings the price down of everything. Since the price is now lower, your money can buy you more shares. It’s similar to things that you buy everyday; would you rather buy butter on sale for $1.99 or at regular price for 3.99?
As painful as corrections may be, they’re pretty rare. The 2008 correction was massive so that was our last point of reference when markets started to fall in August. A huge stock market drop is rare so it’s best to just stay the course. What most people also don’t understand is that corrections are often healthy since they tend to happen due to a result of some kind of problem in a certain sector. When markets are at all time peaks, it implies that it’s “fully valued” which makes it harder for our investments to grow, it can also scare off new investors who are worried of a potential crash.
To be clear, selling your losers and buying what’s hot is never a good idea. You’re basically selling low and buying high.
Stick to your plan
We all have a financial plan right? It doesn’t have to extremely detailed, but we should at least know how what our money is invested in. We also need to make sure we have the right mix of assets for our age and risk tolerance. Investments are really broken down into 2 categories: equities, which are riskier but offer potentially better returns, and fixed income – safe investments with limited returns. The combination of the 2 makes up our asset allocation.
When we’re younger we can afford to take more risks with our portfolio so we should have a higher amount allocated to equities; whereas someone nearing retirement probably wants to have more of their portfolio in safer fixed income investments. Now if we’ve stuck to our plan and have the right mix then it doesn’t matter how the markets are doing. The pullback earlier this year won’t matter much to someone in their 30’s since they can still recover. Those nearing retirement will feel the sting a little bit, but in theory they have a lot of their money in safe investments so it shouldn’t matter too much.
If our investments start to stray from your intended asset allocation by say 5% then just re-balance so we’re back on course. What that means is that we’ll sell some of our investments that have been doing well, and buy more of what’s been down. We’re essentially selling high and buying low. Can’t get much better than that. Of course you need to make sure your asset allocation setup so never underestimate the value of hiring a financial advisor.[icon name=”share”] Related: Money terms you need to know
A stock market drop does happen from time to time, so it’s important to remember that it really doesn’t matter in the long run. Stick to your financial plan and don’t let the headlines scare you.