At the end of 2018, the US indices made a late rally on New Year’s Eve to barely avoid transitioning from the current ‘longest ever Bull market’ to a bear market, but the Stock Market Crash made for grim reading to investors in the markets.
For context, the Dow Jones index in the USA ended up with an overall loss of 5.8% on the year, and the S&P500 fared worse with a 6.2% drop.
The year had seen two major corrections of almost 10% from the previous highs before.
December 2018 also had the unique situation of being the worst performing December since 1931, but also giving the highest point gain for the Dow Jones – very volatile indeed!
Is the Stock Market Crash a Sign I Should Sell my Holdings?
It is common for normal investors to have holdings in index funds or ETFs such as the Vanguard Total Stock Market Index Fund, or the Dow Jones U.S. Completion Stock Market Index as a way of getting a better return than the savings accounts of their banks offer.
If you invest or even follow the stock market, you will have observed in the long term, a clearly defined economic cycle of “boom and bust” where the market will rise steadily in a bull market, and then drop sharply and rapidly at the end of the cycle signalling a bear market.
It is precisely the fact that gains built up by investors in positions over a long period of time (say 5+ years), can be wiped out entirely in the course of a few months.
This volatility in times of stress is enough to create a fear with investors where they rush to liquidate their positions as quick as possible, and exacerbate the issue, tempting more investors to do the same, which seems to perpetuate the vicious cycle of losses.
But there is clear historical evidence that stock markets have made significant, positive annual returns even when accounting for stock market crashes.
Even though it could be argued that liquidating your positions in the stock market that performs well on average over time due to short term volatility is irrational, in practice it feels very rational to liquidate and protect your investment.
So if you have positions in the market and suspect that the market is about to take a turn for the worst, but you are struggling to push against your urge to liquidate, what factors should you consider?
Assess why you are Investing in the Stock Market in the First Place
The fact that you have taken the opportunity to place your savings in the stock market means that the returns you can get from your typical savings accounts are probably not enough for you, and you want to make your money work.
Here are some typical reasons that investors decide to choose the Stock Market:
- Build up enough investment to give yourself the ability to retire early (i.e. achieve financial independence),
- Stash away investments to cover any potential life expenses such as child expenses (school, university), or for aging parents,
- Provide a risk based return that is in excess of that provided by standard treasury bonds (the ‘risk free rate’).
It is important to assess your reasons for investing in the first place. If you are looking to make short term profits from the market, then investing your savings here is probably not for you (unless you are an exceptional day trader with a large funding pool).
A medium to long term investment horizon can remind you that despite daily fluctuations in stock price, you still own the portfolio, and there is a high likelihood that the value will return to your previous high, and likely continue beyond that.
Remember that the ‘FANG’ stocks which crashed during the dot-com bubble have since reached a value in excess of their previous highs before that bubble.
What is your Tolerance to Risk?
It is important to ask yourself: “Am I risk loving, or more risk averse?” The difference between the two is really defined by the loss you are willing to handle in the event of a market crash.
Say you have £10,000 invested; at what point are you going to think about liquidating your positions?
Generally, a risk averse person would probably liquidate at a 10% absolute loss, but a risk loving person would know that the stock market generally tends in an upward direction even accounting for the boom and bust cycle.
Your risk tolerance will be a large factor in deciding whether you can continue to invest even when the market starts to pick up again.
No one can make any stock market predictions with any certainty, so ignore the doomsday news articles, and just think about what you are willing to lose.
Assess the Work Needed to Make up for any Loss
If you have the £10,000 theoretical portfolio, and you lose 10%, then you are down £1,000.
The majority of you will have a main income stream which allows you to invest in the stock market in the first place, so assess how long it would take for you to make up for the loss – this can help you to contextualise the relative loss rather than the absolute.
The goal to achieving financial independence is generally about ensuring that your net worth is more this month than the previous.
If you liquidate the remaining £9,000 of assets in your portfolio and place it back into a savings account that isn’t able to even match inflation, you could be losing wealth every month.
Make Sure to do your Homework, and Check the Historical Performance of Your Portfolio
If you have a rough portfolio composition that you aim for (e.g. 40% Stocks, 60% Bonds), then you can easily check the historic performance of your portfolio to get an expectation of how that portfolio should perform through times of stress.
The Vanguard Group which is a significant investment company with around $3tn in global assets under management produces historical portfolio returns for compositions such as above from 1926 to present.
If we use our theoretical portfolio above as an example, accounting for previous stock market crashes such as the Great Depression, Dot Com Bubble, Financial Crisis etc., then the 40% Stocks/60% Bonds composition has achieved an average 7.8% return each year, with the worst year -18%, and best year +28%.
This can help you to calibrate your expectations for a worst case scenario, while still seeing the benefit of continued investment.
If you are 30, with a £10,000 investment in this portfolio composition, and do not invest anything more until you are 60, then your stock market portfolio could be worth £95,000!
Ensure that you have a Cash Buffer in a Downturn
It is also important to ensure that you are not putting your entire savings into the stock market.
Typically if there is a stock market crash, then the economy is also under pressure: unemployment steadily rises and pay rises become less frequent (just to name two symptoms which could affect you personally).
If you find yourself in a situation where you need to access your money in an emergency, liquidating positions with a potential penalty fee, or at a value less than you invested at, can be a psychological blow.
Having an emergency fund in cash can give you a peace of mind to make a more rational decision in times of stress.
It was also the best performing asset of 2018!
Be Active Rather than Passive
If you do decide that you are taking a long term view, and will ride the storm, don’t just sit there and wait for it to pass.
Knowing that the market tends upwards on average means that a ‘bottomed-out’ market is a significant buying opportunity, and you need to be ready to increase your investments to account for this.
In 2008 which was the worst performing year financially in the last 100 years, the stock market lost around 40% of its total value.
If you purchased the assets at this price, then you would have bought at the best possible time for portfolio growth – though this is not to say that you should try and time the market if you are making your first investments as you could be missing out on returns waiting for the perfect opportunity!
It is also important to note that while my points focus on not liquidating positions in a downturn, you may also have a solid belief that selling now could mean that you can buy back a larger portion of the market when it bottoms out – this is active management with the intention of continuing your investment in the market, rather than getting spooked and exiting the market altogether.
Define your Goal
This is my final point, and what I believe to be a very important one.
I ask this to myself often after an old colleague of mine told me what he asks his clients in his real estate investing business: “What does reaching your goal look like?”
I outlined typical reasons above that you might have for setting up your investments, but there are no success criteria to go along with them.
If you are saving for your children’s future, then how much are you aiming to save?
If you are saving for financial independence, then how much do you need from your investments each month to sustain your target lifestyle?
It is important to evaluate the goal because it can help you to refocus on why you are investing in the first place, and give you a tangible number/event to work towards.
Make sure to evaluate all of the points I have outlined above, particularly if you are heavily invested in the markets.
If you are going to search google for “what time does the stock market open”, be open minded about even increasing your position especially when the stocks are cheaper than before.
If you are not already investing in your future, then hopefully this post will give you some drive to set up your own portfolio to start building wealth that grows for you, rather than leaving it to languish in those savings accounts with low interest rates.