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Imagine this: you are in a car and it is sinking.
You try pulling on the door handles but they won’t open because the pressure on the outside of the car is much greater than the pressure inside the car. What do you do? More likely than not, you are now panicking and you can’t think clearly. If you were thinking clearly, you might remember the driver’s education 101 tip that says stay calm. If you have patience and wait for the car to fully submerge, the pressure on the inside and outside of the car will be equal and you should be able to open the door.
A similar thing happens in the world of investing. During times of crisis, our instincts cause us to panic and forget everything we have learned.
When a crisis arises, we tend to take the first action we can think of, even if it is not the best one. It takes a lot of patience and mental discipline to be able to watch a market dropping without pulling out your cash, but there is a huge difference in your returns if you remain calm. From November 1, 2015, through February 11, 2016, the global stock market fell about 15% before rallying 31% to today’s level. If you had sold at this time out of fear, though, you would be up only 4% compared to the 20% cumulative you’d be up if you had remained steady.
Source: data from Xignite, total returns data for ACWI ETF representing global stock markets, chart from Betterment
The best advice you can be given is: understand the level of risk that you are taking in your current portfolio and make sure that you are comfortable taking on that level of risk. Your risk level is closely tied to your financial plan. You should ask yourself if you are taking too much or too little risk to accomplish your goals. Are you saving enough to achieve your goals? Are you using unreasonable future growth assumptions to accomplish your goals? If you are honest with yourself and realize you are taking on more risk than you are comfortable with, you should adjust your risk level and financial plan as soon as possible, not as a reactionary measure to a market downturn. Additionally, regardless of your risk tolerance, everyone should have an emergency fund that is invested conservatively as a fallback.
Related: The Big Problem with Buy Low, Sell High Advice
If you feel that you are taking a level of risk that you are comfortable with, but are still worried about your own panic getting in the way of your plans – draft a plan now for how you will deal with it. If you can’t handle seeing the color red, logging into your portfolio every day is probably not recommended. Ask yourself where there is wiggle room in your financial plan. Prioritizing your goals and figuring out what you would do differently if the need arose is a good way to feel more secure if things are not going well.
If you think making changes to your portfolio is the right move, make sure get a second opinion from someone with a level-head. At Sherman Wealth Management, we are committed to answering all of your questions, addressing your concerns and helping you to avoid common behavioral mistakes. When you imagine yourself in a sinking car, rest assured that we are right there to coach you through it.