When is it best to do nothing? Strategies for helping you deal with market downturns.

Losing hurts more than winning

No one likes to lose, in fact, losing has a bigger impact on us than winning. Studies on “Loss Aversion” show that incurring losses impacts us twice as much as making the same gain. From an investment perspective this makes us act in ways which can be contrary to our long term benefit. Buying at the wrong time and panic selling can devastate your portfolio’s performance.
 
So lets look at some of the things that we do and some things that we can do better.

losing has a bigger impact than winning

Timeframe is everything!

If you’re invested appropriately for your timeframe, then market volatility isn’t an issue. That is the longer the time you have before needing to use the capital the more time you have for assets to recover. This means there’s no reason why you should incur losses unless they’re self inflicted. If you’re investing in capital markets you should have a 10 year plus time horizon.

If you need to use your money in the next couple of years then investing in capital markets is a mistake. If markets do start to fall then you’re not going to have the time to wait for them to recover. Over this timeframe you should be looking at a savings account.
 
Get this right and investing will be much less stressful.

getting this right makes investing less stressful

taking our medicine

When there is a market correction our gut instinct is to get out, cut our losses and move into cash. What does this actually do for us, how does it help our capital grow? The answer to those questions are, Nothing and it doesn’t!
 
In fact in reality it is damaging because it moves us backwards with no hope of moving forward. By selling assets when they’ve started to make losses you make them real. If you keep hold of the assets those losses are on paper and unrealised. As market cycles move on those assets begin to recover and then add growth to your portfolio. Markets recover, sometimes it will be a quick bounce, other times it can be a long and slow recovery.
 
If an asset that you hold starts to run into trouble then the action that you take may be different. Whether it’s a fund or share and things start to go wrong then you should consider getting rid of that asset.
Holding on for dear life could prove to be a mistake. This is different to having investments and the market starts to correct. If an investment if falling in value as the market if going down, then this is part of investing. Hey it even happens in the property market.
 
We seem to struggle with this principle and instead prefer the perceived safety of cash. The key thing to recognise here is that markets go up and down, they recover. If you can’t afford to make these paper losses then you shouldn’t be investing. Remember the money that we put into capital markets should be money we don’t need soon. So why not just leave it alone?
 
After all if your property’s value fell by 40% over a year would you rush to sell it?

as market cycles move assets recover

the best medicine

Contrary to our natural instincts the best thing that we can do when markets fall is to add money into them. Think of it as a sale, we all like sales don’t we? If you can get something that you already want for 10,20,30 or 40% less than you were willing to pay for it that’s good. During these uncomfortable periods the last thing that we want to do is exactly what we should be doing.
 
Adding more capital into the markets when they’re falling does a couple of things. First of all markets don’t have to recover completely before you start to make money again.
You don’t have to come back to pre-crash levels before you’re back in the black. . The second benefit is a little more subtle. As you add more money your valuations start to look better as you are buying the asset at the new lower price. This helps to keep that little voice quiet and reduce the stress levels that a falling market can cause.
 
This is why having a regular contribution investment can be so effective. The money gets invested every month and we don’t think about it. We invest through the good times and the bad and as a result over the long term we benefit.

adding more money means your portfolio recovers quicker

next best thing

If adding more money making an isn’t an option then don’t do anything, except rebalance your portfolio. Sell what has made money and buy what has lost money. We don’t mean sell everything we hold in the money making assets. Sell only the amount over and above the original allocation percentage. If your original allocation for an asset was 5% and now it makes up 7% of your portfolio what should you do? The answer is sell the 2% and reallocate it to assets that have fallen in value. This brings the portfolio back to your original allocation model.
It also has has a similar effect as adding more money to the portfolio. It locks in gains from assets that have grown and the assets that have fallen in value recover quicker. are now lower than the original percentage allocated to the portfolio.
 
As a side note even if you are adding more money into your portfolio you should still rebalance. Do once a year more than this is too frequent. This will only enhance your long term performance further.
 

adding more money means your portfolio recovers quicker

everything's not the same

Just because there is an asset in your portfolio that is losing money right now doesn’t mean that you need to sell it. It’s a common reaction of investors to want to sell assets that they see as “underperforming ”.
 
Sometimes it may be true (though proper asset selection helps prevent this), and if it’s the case sell it. Though it is likely that the assets market sector is going through a downturn.
 
So why isn’t this an underperforming asset? Every asset is cyclical whether it be bonds, equities (shares), property or commodities. Interest rates, government policy, conflict or even climate can influence this cycle. These changes will influence each asset type in a different way. What could prove positive for one may be negative for another type of asset. This situation will change, conditions become more favourable, then asset starts to grow. The opposite is also true.

If an asset is truly underperforming then replace it

too much of a good thing

If everything in your portfolio is doing the same thing at the same time you could do very well. Conversely, it could prove to be an issue because if everything goes up at the same time it will fall at the same time. What do you do then?
 
If you don’t have a strong constitution then you should diversify.

a bit of variety

So if you are more conservative and prefer a smoother ride diversity will give you this. You’ll be investing in assets that do different things at different times. Whilst some holdings are going up in value others will go down. The ones that are going down will do the job that you need them to do at some point in the future as the cycle progresses.
 

beware of soothsayers

I’m sure some of you are thinking “well why don’t we buy these assets when we need them? ” Well the reason for this is that market timing is a mugs game. Even if you know what is going to happen you have no way of knowing when. Even the most advanced predictive modelling systems can’t tell us the when.
 
Market timers generally buy high and sell low. This is because they get in after an asset has gathered momentum and sell as markets are on the way down. Plus how do you know you’re not experiencing a short term correction?
If it’s not a full blown downturn and markets start to go back up again what then? The answer is, you don’t know and neither does anyone else. Anything else is opinion and conjecture.
 
This is why we should allocate in this way and accept that not all assets are going to go up in value at the same time. So if you think an asset is underperforming, before you do anything else check. See what it’s doing against its peers and you may find that you have an asset that is outperforming. If an assets sector is in a downward stage of the cycle there is only so much they can do performance wise. If it is underperforming then replace it like for like.
 

market timers buy high and sell low

summing it all up

The conclusion to all of this is that if you have allocated correctly in the first place. Made investment decisions based on your investment timeframe and good asset selection.  Then market corrections and cycles shouldn’t cause you enormous concern. Put the little voice in it’s place and do nothing.

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