What to do when the stock market drops

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Even if you ignore the daily news’ recap of changes in the stock market, it’s almost impossible to avoid the headlines when there are big drops—or “corrections”—in the market.

As you’re probably painfully aware, the last few years have been especially volatile given the devastating economic effects of the pandemic. While the rebound that followed provided some relief, subsequent supply chain issues, the war in Ukraine, historic inflation, and record-high gas prices were just some of the many factors that affected large swaths of the economy and the ups and downs of the stock market.

Even if you’re not especially invested (pun intended) in what’s going on with the stock market, headlines during a correction may prompt you to sign into your accounts and see how much money you’ve “lost.” But what then?

“Market drops are an expected and unavoidable part of investing,” says Ryan Inman, a fee-only financial planner for physicians. “Preparing for a market correction should be part of your investment approach.”

First, take a deep breath

“If you see a big drop in your portfolio, the first thing to do is take a deep breath and stay calm,” says Inman. Of course, it can be difficult to completely remove emotions from the equation when you’ve suddenly lost 10% of your invested money. Figuratively stepping away from the situation, taking a few big breaths, and re-evaluating what’s happening could help you respond rather than react to a stressful moment.

“Ask yourself if a temporary decline in your investment portfolio value will force you to make any adjustments to your current lifestyle,” says Inman. “Remember what you are investing for and that your long-term allocation may have already factored in temporary declines in the market.”

In other words, if you’re saving for retirement which may be several decades away, or even to buy a home in 5-10 years, a short-term drop likely will not have a significant impact on your long-term results.

But if you’re investing for something that you’ll need money for in the next 1-2 years, a cash savings account may be the best choice to keep your money safe.

How will you respond?

Bear markets—large drops that may last months or years—and short-term corrections can lead to a lower balance in your investment account. It’s never fun to lose money, but that doesn’t mean you should panic or take action right away.

“[Bear markets] are both common and to be expected many times during your 50-plus year total investment timeline,” says Dan Murphy, founder of Greater Good Financial. In other words, it’s normal and it’s no reason to get worried even if your investment balance temporarily dips.

Dan Egan, managing director of behavioral investing at robo-advisor Betterment.com, suggested that investors take their emotions through a fire-drill to be prepared.

This is what experts generally recommend.

• Stay the course.

   

  “If you’re scared and worried about your money, your best action may be the one with the least amount of involvement,” says Murphy. Continuing to make the same regular contributions, also known as dollar-cost averaging, could help you stay on course for your long-term goals without having to worry about the current fluctuations in the market.

• Buy new investments.

   

  Some people keep cash and wait for a stock market correction. They view it as a “sale” on investments, since you’ll be able to purchase more shares with the same amount of money. You might then get greater returns on your investment as the market rises.

• Don’t sell your investments.

   

  Some may be tempted to ditch investments before they drop even lower or sell everything and move to cash. This is often viewed as a mistake and research has shown that market timing almost never works. “Don’t try to time the market as you might miss out on the gains as the market starts to move back in the upward direction,” says Inman. You could wind up selling low and then buying high.

If you have invested in a robo-advisor portfolio, you won’t have to worry about the next two things—rebalancing or tax-loss harvesting—as the mainstream services will take care of this for you. However, if you actively manage your own portfolio of investment, you may want to do the following after a big market change.

• Rebalance your portfolio.

   

  “If you take a more active approach to managing your investments, you may want to see how your asset allocation has changed due to the correction. You could rebalance as the market goes down,” says Murphy, “then let your winners run as the market starts to rise again.”

• Harvest losses for tax purposes.

   

  It may make sense to strategically sell certain investments that are at a loss and then rebuy similar investments. As a result, you keep your overall investment position but can claim the losses as a write-off on your taxes. It’s a strategy known as tax-loss harvesting, and if you think this might work for your portfolio, you should read more or ask a professional for advice to make sure you don’t mistakenly break any rules or regulations.

Create a strategy ahead of time

While you might not be able to predict when corrections will happen, it’s almost certain that they will. It could be as often as at least once a year, but the market also tends to rebound within a few months.

If you’d rather stay hands-off, staying the course and continuing to make regular contributions to your accounts and investments is the simplest option—and likely so for many people.

If you actively manage your investments, a correction could be an indication that it’s time to rebalance your portfolio, look for tax-loss harvesting opportunities, or shop for stocks that are undervalued.

Also, this is also a good time to make sure that you feel comfortable with the cash you have in a high-yield savings account. Many experts recommend people have between 3-6 months of cash in an emergency fund to cover expenses if you lose your job or source of income temporarily.

Consider your options now and decide on your strategy. You may want to write down your decision so you can pull out your note if you’re feeling fearful or reactionary after a big drop. And if you want a second opinion, you could always hire a financial planner to review your portfolio and make suggestions. 

The key here is to act rationally when it comes to your investments, even if the market undergoes a correction. Keep your eye on your long term financial goals and do the necessary research to ensure you’re on the right path, even if there’s a temporary bump in the road.

Unless otherwise noted above, opinions, advice, services, or other information or content expressed or contributed by customers or non-Varo contributors do not necessarily state or reflect those of Varo Bank, N.A. Member FDIC (“Bank”). Bank is not responsible for the accuracy of any content provided by author(s) or contributor(s) other than Varo.