Broker Check

What Happens if the Market Goes Down?

January 25, 2022
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More people are engaged in stock market activities than ever before. With smartphone applications, retirement plans, and self-directed brokerage accounts, people have the same access to the stock market as they do the local grocery store. The term “gamification” was coined relating ease of access to the stock market. With trades placed on a whim, there is often no regard to consequences. The consequences of high volume, erratic trading are taxes on gains, trading fees, and ultimately market manipulation (such as the GameStop phenomenon in 2021). Whether it be panic or conspiracy, when high volumes of frivolous trades get called in, it can certainly sway markets in the short-term; although, over time, the market should self-correct.

It used to be a financial advisor’s job to provide access to markets; this is not always the case now. Although investing through a financial advisor often is pretty boring compared to quick purchases through a self-directed phone application, investing, I believe, was always supposed to be a little boring: design a plan and let it work for a few decades. A well-diversified portfolio is also frustrating much of the time because something is always not working; if the investments are truly diversified and uncorrelated, then while one asset class is doing well, another asset class might be lagging a bit. A diversified portfolio, over time, is supposed build in value while the market indexes appear much more volatile. We often expect to put money into the stock market and see immediate impact, but that’s rarely the way it works. So what happens if we invest money into the market, and the market declines? What happens if the economy enters another recession?

The difference between a financial plan and an investment account is that a financial plan will often encompass a greater viewpoint. An investment account is focused solely on growth in one or two accounts. While they are supposed to work together, I think many advisors focus on investment accounts and call the growth generated from the investment a plan. In a financial plan, a wider viewpoint is encouraged. In a downward-trending market, the focus on an investment account might lead to worries about account values and short-term declines; a financial plan, on the other hand, might see a downward-trending market as an opportunity to “buy low.”

So what should you do in a down market? It all depends on your plan, your capacity to act, and your willingness to look ahead. Risk, in my opinion, is relative. In examining an individual stock position, risk is very meaningful. When looking at a well-diversified and uncorrelated mix of investment instruments, risk becomes as diversified as the types of investment instruments. When one investment is declining, one might be holding steady.

There are typically three options for everyone in a downward-trending market. Let’s investigate them a bit.

Sell shares and move to cash. If this is your reaction to a downward-trending market, you should really ask yourself if you belong investing in the stock market at all. It is likely possible you invested money that had an immediate need instead of a future need, or it is possible that you desire more conservative investments. More conservative investments are usually found in savings instruments that carry either lower returns, higher costs, or both.

It’s no secret that the fundamental method to “make money” in the market is to buy low and sell high. Selling out in a down market is exactly opposite of this strategy, yet I always hear people ask if they should move to cash if they sense a market fluctuation. I don’t necessarily see anything wrong with rebalancing if you feel something isn’t working, but I have seen quite a bit of irrational behavior and lost opportunity during falling markets. People often believe that investing in high-market-times is good and investing in low-market-times is bad. Strangely, it’s the exact opposite that results in profitable investments, and I’ve learned that for many people, this is an ideology that is very difficult to follow.

Here’s a quick example. I met with the president of a small bank (he is not a client) not long after the 2008 recession. He had about $300,000 of funds saved up, and he was retiring soon. I asked him about this account, and he said it was nearly $800,000 at one time, but he sold shares after the market dropped in 2008 and ultimately moved to cash. I was floored. If he simply stayed the course, he would have had well over $1,000,000 in the account, but he sold shares and essentially “locked in” his losses. It’s perfectly OK to feel a bit uneasy about an unsteady market, and this is a pretty extreme example, but it seemed like he should not have been investing in the kinds of investments he had in the first place. I don’t want to seem insensitive, but if the first thing that crosses your mind in a down market is to move to cash, then something is likely wrong with the plan in place, and it should probably be addressed to some degree.

Stay the course and “let it ride.” I always like this plan. If you’re unsure, but you feel confident in the big picture, you can always wait and see. There’s nothing wrong with staying put, charting the economic landscape, and developing a plan about how to move forward. In my opinion, staying the course is somewhat taking control of the situation. When the market changes wildly, there is almost always an urge to act, and doing nothing is sometimes the only way to really take control and assess what to do. Because when you do nothing with the investment account, you generally are reevaluating the plan and gaining understanding of the situation. We strangely often work the hardest when we “do nothing.”

Invest more. This is an aggressive approach that I personally identify with. As long as your income is not in jeopardy and you don’t deplete your savings, investing in a down market is a textbook move. Imagine you were shopping for a computer, and you found one for $500, brand new in the store. The very next day, you saw the exact same computer for $375. Which one would you choose? Of course you would choose the cheaper computer. The same concept applies to buying shares in a falling market. I always call falling markets good funding years. The returns aren’t pretty in that particular year, but if you choose to fund an account during a down year, the future returns can work out nicely.

Here’s what I often suggest people do in a falling market if they are interested in taking advantage of potential lower prices: develop a time-based strategy to move money in the market. Along with normal dollar cost averaging (continual, steady contributions into an investment account), determine an allotment of funds to move into the investment account. Once that decision is made, break up that allotment into smaller pieces. For example, if someone wants to put $20,000 in additional funds into the market, you don’t necessarily need to dump all $20,000 in at once. Take advantage of a falling market, but don’t try to time it perfectly. Maybe move $5,000 in first. Then wait a week or a month or a predetermined amount of time to move on the next round of funding and so on. This allows you to somewhat merge the “invest more” action with the “wait and see” ideology.

Whatever path you choose in a falling market, whether it’s to move to cash, stay the course, or invest more, you should always consider the bigger picture. Good advisors are taught to look at a situation and expand their viewpoint of the future. While many people might be able to envision a plan for 2 to 5 years down the road, advisors are often trained to calculate decades into the future. There is no crystal ball that explains, predicts, or hints at what might happen in the future; however, certain behaviors are rewarded in the world of financial planning, and it so happens that sometimes even doing nothing is a behavior that often gets rewarded!