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MANY INVESTORS endured their first stock market crash this year. But what if you’ve never before invested in stocks? How do you know what your risk tolerance is—and how do you keep yourself calm?
There are no easy answers. Questionnaires aren’t a great way to find out our risk tolerance. They ask us about hypotheticals when we’re calm, but we act and think differently when the storm hits. Instead, the only sure way to find out our risk tolerance is to weather a storm or two.
As a relatively new investor, I had no idea how I’d react to 2020’s bear market. March gave me my first real test. At the beginning, I struggled not to panic when some of my investments were down more than 50%. As the turmoil continued, however, I did my best to make the most of a painful time, including coming up with strategies to handle my emotions. Here are six of those strategies:
1. Reframe the situation. Market downturns will keep happening. It’s up to us to view them not as losses, but opportunities. Say we bought stocks in January, before the selloff. Why shouldn’t we buy more when shares plunge 30%?
Yes, the market could indeed fall further, but nobody has a crystal ball. We know, however, that stocks are cheaper today than a few months ago—and that they should generate higher returns if we buy at lower valuations. If we were buying when stocks were higher, we should be even more enthused now that prices are lower. If anything, we should increase the amount we invest each month.
2. Consider your time horizon. If we’re investing in the stock market, we most likely don’t need that money for the foreseeable future—maybe not even for decades. Bear markets are temporary. Most of the time, investing in the stock market is the smart long-term choice, especially if we buy at times of crisis. If we’re young, we should be grateful for the chance to buy at today’s lower prices—and that we have many years ahead of us for our stock market investments to appreciate.
3. Focus on the amount you invest. Early in life, the savings we put away matter much more than the investment returns we get, while the reverse is true as we grow older. For instance, if we have $10,000 invested today, losing 30% shrinks our portfolio by $3,000—a hit that we might be able offset with a few months of savings. Fast forward three decades and imagine we have $1 million invested. A 30% drop would knock $300,000 off our portfolio’s value—a loss we couldn’t possibly make up simply by saving more in the months ahead.
4. Remember that your net worth is more than just your stocks. We may have a house, bonds, bank deposits and other assets, as well as our income-earning ability. A 30% decrease in the stock market doesn’t mean our total wealth falls 30%—it’s far less than that.
5. Curate your news consumption. Not all financial content is created equal. We’d do well to dedicate time to reading, watching and listening to advice that calms us and helps us control our emotions, rather than to news that fixates on plunging stocks and forecasts about the end of the world.
As share prices tumbled, I consumed a lot of information that helped me navigate the situation and stay calm. But you might opt to disconnect from the financial news entirely. For extra points, forbid yourself from monitoring your investments on a daily basis.
6. Have a plan. All of the above is easier said than done. Pondering these things before we experience a market crash isn’t the same as living through one, but it helps to prepare us. When the next crisis hits, we may not stick to our carefully drawn up action plan—but we certainly can’t stick to our plan if we don’t have one in the first place.
Marc Bisbal Arias holds a bachelor’s degree in business and economics, and is a Level I candidate to become a Chartered Financial Analyst charterholder. He started his professional career at Morningstar, performing research and editorial tasks, and is currently employed by Dow Jones in Barcelona, Spain. Marc’s previous article was Setting Boundaries. Follow him on Twitter @BAMarc.
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Interesting read, thanks for posting. Point number 3 can be hard to digest; @ age 67, retired for 5 years, a 30% drop is at the least uncomfortable. I seem to look at it as how much it relates to annual income when I was working. This of course leads to point # 6, have a plan, and I would add have a financial advisor you have the upmost confidence in. Use these times to rebalance and take advantage of tax harvesting. I wish I had read Peter Mallouk’s book “The 5 Mistakes every investor makes” at a younger age.
Point #2 keeps me calm for now, although that probably won’t work for me 20 or 30 years down the road.
Another tip is to create a lifestyle where you have a lot of margin for error. If you only draw 3% or less of your portfolio’s value annually when retired, you have some cushion against things going wrong and sequence-of-return risk.
Number 6 makes all the other advice work. Without a plan you’re just trusting to luck, to history, to the corrections of deviation from the mean. With a plan (a plan that covers worst case scenarios), you don’t need to trust to anything – you can be secure that you know exactly what to do if you lose your job (and your spouse loses theirs) and we have a ten year recession/depression. You may still take losses, but you also have a path to travel that will keep you solvent.
Good advice Marc. I think it supports having a portfolio appropriate to your situation. I de-risked a few years ago and have been fairly calm this time around.
From Warren Buffett: “A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves”.
“But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying”.
If you’re thinking of taking a car trip, and couldn’t get a traffic report, would you worry about traffic being unexpectedly light? Would that make your prospective trip risky? I don’t think so. Ordinarily, “risk” refers to an event being dangerous, with some chance of something bad happening, not something good. Yet in investing, the chance that an investment will be unexpectedly profitable makes it “risky”. This language is misleading. I prefer the term “volatile” for an investment whose value may go up or down. Calling stocks “risky” is really a form of the investor fallacy “loss aversion” — the fear of loss overwhelming the wish for gain.
So what should we do in a market crash? I think stocks are volatile, but not dangerous, so I say: Buy. I started investing in 1972 and have been through 4 crashes. By 2008, I had finally figured out that crashes are times to buy, so I did, and was pleased with the result. Earlier this year in Feb-April, it really didn’t occur to me to sell. I bought, and my portfolio of mutual funds is up 27% year-to-date.