Global stock markets appreciate steadily over the long term, it is an undeniable historical fact. That being said, a crisis will most certainly pop up sooner or later and temporarily halt the uptrend. Unfortunately, this is the limit of our ability to predict the future, and let’s be honest, no one can formally predict the timing of the next downturn, neither its duration or its magnitude.
A "crisis" will thus show up one day or another. But what does this mean concretely? A crisis is a stock market depreciation of at least 15%. A 5-10% drop is thus not a crisis, but merely a temporary correction that can occur several times a year. If our brain tends to remember only major crises - 1929, 2000, 2008 – market drops of more than 15% are quite frequent. It was for instance the case in 2011 or more recently in early 2016.
Since crises are so frequent, any investor should better be prepared. But how to react when the time comes? Should you panic and liquidate your portfolio in the middle of the fall in the hope of buying back cheaper at a later stage? Should you hide under a mountain of gold? Please, don’t do any of this, it's the best way to crystallize your losses forever, you will regret it! Instead, follow our 5 recommendations that will help you adopt the right attitude.
We are human being and therefore inclined to be overwhelmed by our emotions when a financial crisis strikes. Unfortunately, panic selling is never a winning investment strategy. The best way to avoid panicking is to avoid facing in a situation you cannot tolerate. Since we are not all emotionally equal, everyone has his own tolerance optimum. Take the time to define your investment plan and opt for a risk profile adapted to your personality and your projects. Over time, always keep your portfolio aligned with this profile. You will avoid the temptation to make bad financial decisions at the worst time.
In times of financial crisis, stocks and bonds prices follow opposite trajectories. If the decline is significant, the weight of equities in your portfolio will decrease enough to cause your portfolio to deviate from its risk optimum. A market downturn is thus a perfect opportunity to rebalance your portfolio. This implies selling some of your bonds to buy stocks when they are cheap. This approach, which may seem counternatural in times of crisis, will bring you back in line with your risk profile and improve your long-term return.
It is important to continue to apply your investment plan methodically as initially defined. Only changes to your life projects and your financial requirements should affect your plan, but never market fluctuations. If an investment is scheduled periodically as part of your plan, it should not be postponed due to a market downturn, quite the opposite. The decline is an opportunity you should seize without a second thought.
If drops are part of the journey, always keep in mind that they are just bumps on the road. Over the last 50 years, periods of market appreciation lasted on average 4 years against only 9 months for market drops. The rebound period following a decline is even shorter and losses are most often erased after only 6 months. The temporary decline will be quickly forgotten, and you will soon find yourself climbing up to new highs.
Do not even think about it! You are more likely to win at heads and tails than to time the market correctly. Following your intuitions will lead you at best to reduce your performance, at worst to crystallize your losses for good. Since markets rise 7 years out of 10 and rise even more just before a market drop, trying to anticipate a crisis will most likely lead you to passively watch stocks ascending and missing a great rally. On the other hand, selling in the midst of a crisis in the hope of buying lower is a clear violation of our first recommendation. Identifying the bottom of the decline is just as illusory as anticipating the crisis, and much costlier. Fail to perfectly identify the bottom by a few days and you will have missed the best trading days of the year. In that perspective, you should rather wait patiently for the rebound that will come sooner or later.
Although these principles seem simple, their application is not that straightforward. A financial coach like easyvest can help you stay focus whatever the circumstances. Our planning and monitoring tools allow you to quickly define your personal plan and implement it rigorously. In case of imbalance of your portfolio, we alert you immediately to take appropriate actions. Our private advisors are available at any time to answer your questions and calm your concerns. They will help you rationalize your investment decisions, take a step back and avoid overconfidence traps.
Note: This article was written when Easyvest was authorized and regulated by the FSMA as an agent in banking and investment services.