By Brad Wright, CFP
It’s become a running joke that when I walk into a television newsroom, the anchors groan: “Oh, Brad’s here again. The market must be down.” That’s because they only call me when the market is cascading, and viewers are freaking out. They appreciate the fact that I can show up, speak with them for 90 seconds and calm the masses. I offer to pop in on a good day with equally beneficial advice, but so far, they haven’t taken me up on it. Unless you’re working with a financial advisor and have been properly planning to be prepared for a market correction, bear market, recession, etc., you may react in a similar fashion.
Amos Tversky and Daniel Kahneman identified Loss Aversion as one’s tendency to prefer avoiding losses to acquiring equivalent gains (Kahneman, D., & Tversky, A. (1977). Prospect Theory. An Analysis of Decision Making Under Risk. doi:10.21236/ada045771). Further studies have suggested that losses are twice as psychologically powerful as gains. This implies that someone who loses $500 will be more upset than she would be happy if she won $500.
It should come as no surprise then, that many investors want to make changes to their portfolios when the market is closer to a bottom than a top. However, selling low and buying high is not a strategy that will make you rich.
What should you do instead?
- First, realize that downturns are not rare events. They happen…a lot. According to Vanguard, since 1980 there have been 19 corrections (declines of 10% or more), 10 bear markets (declines of 20% or more, at least two months long), and six recessions (declines in economic conditions for two or more successive quarters). We’ve recovered from all of them.
- Second, if you’re feeling that urge to sell and move everything to cash, speak with a financial professional first. Yes, there are cases where raising some cash might make sense, but moving to 100% cash increases the likelihood of missing out on a strong recovery that typically follows market downturns. If you had missed even a handful of the best trading days over the past 20 years, you would have severely underperformed the market as a whole. As recently as 2020, the COVID-19 pandemic sent the S&P Index (The S&P 500 consists of 500 stocks chosen for market size, liquidity, and industry group representation. Each stock’s weight in the index is proportionate to its market value.) plummeting, but had you endured, you would have most likely made money by year-end.
- Third, devise a game plan before the next market pullback, so that you’ll know what to expect and your portfolio will be prepared. As an example, if you depend on your investment accounts to supplement your income, perhaps you can begin creating a cash bucket, so that the next time the market falls and you need money, you won’t need to sell anything. That would likely relieve some stress. Focus on controlling what you can control. Assess your investment risk tolerance. Diversify your assets according to your risk and your time horizon. Pay attention to the costs of whichever investment vehicle(s) you’re utilizing.
The bottom line is that market downturns happen. Fortunately, they don’t last forever. With proper planning, you’ll be able to ignore the short-term pullbacks of the market and remain focused on your long-term goals.
Maybe someday, the news anchors will allow me to share this advice.
About the author: Brad Wright, CFP®
Brad Wright, CFP® is co-founder of Launch Financial Planning, LLC, a fee-only firm located in Andover, MA. He is a frequent contributor to WCVB-TV and Mix 104-1 Radio. Brad is past-President of the Financial Planning Association of New England. Learn more about Brad at www.LaunchFP.com
The opinions penned here are for general information only and are not intended to provide specific advice or recommendations for any individual.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Any opinions are those of Brad Wright.