As many retirement savers and investors know, when the stock market plummets, the fallout can devastate your portfolio. According to data from the Federal Reserve, falling stock markets have wiped out $9 trillion in wealth from American holdings this year alone. The S&P 500 Index has dropped nearly 20% year-to-date, and the tech-heavy Nasdaq Composite Index has slipped 30%.
Experienced investors may have pulled their funds from regular stocks, reallocating their assets to ready themselves for changing economic conditions. But what about the regular investor who, like many others, was hit by the value plunge? Should you sell and take the hit to prevent further losses? How do you make money when the stock market falls?
Why do you lose money when the stock market falls?
Investors normally make money when their assets appreciate in value, like when the value of stock market shares rise. In the same way, when those assets depreciate in value, investors can also lose money.
Analysts and fund managers utilize data analysis and technology to estimate how economic conditions may impact the movement of financial markets. They may issue warnings to their investors and they may buy and sell assets to take on a more defensive position in the face of falling stock prices. This often includes selling certain stocks, buying shorter-term assets like bonds or money-market funds and employing the use of derivatives.
Investors with less experience in active trading, like the majority of retirement savers and long-term investors, generally park their money in index or mutual funds through an individual brokerage account like Robinhood or 401(k). These investors may not have the option to reallocate their assets so nimbly or they may have simply chosen not to. So when the markets fall, the value of their invested assets may also tank.
What to do when financial markets fall
First and foremost, if you didn’t take a defensive position before the markets fell, most experts advise investors to leave their funds invested. According to investment giant Charles Schwab, panicking and selling promising stocks in a market plunge locks in your losses and raises your risk of missing key market rebounds. The largest rally occurs at the bottom of a bear market, and timing the market is near impossible, meaning you very likely won’t jump out and back in time to take advantage of the largest bear market upswing.
Selling solid shares in a market plunge locks in your losses and raises your risk of missing key market rebounds.
– Schwab Center for Financial Research
“Unfortunately, investors typically wait until the market drops to get out, then wait until the market shows improvement to get back in,” said Judith Ward, Thought Leadership Director at investment management firm T. Rowe Price.
Investors who sell their stocks during a market fall and then buy again later can end up with 40% less in their accounts after three years compared to someone who stayed the course. Add in subsequent years’ worth of compounding and the difference grows even starker.
Instead, experts recommend ensuring your portfolio is diversified according to your risk tolerance and slowly buying more stocks – even during a bear market. Schwab analysts suggest that a dollar-cost averaging approach can help manage risk during a volatile market. By investing a set amount of money at regular intervals no matter how the stock market is performing, you’ll be able to buy more shares when prices are lower and fewer shares when prices are higher. In the end, the ups and downs even out.
While you can certainly choose to buy individual company shares, you can also buy shares of funds, such as mutual funds and exchange-traded funds (ETFs). These are often diversified to pursue specific investment strategies, and may even earn money when the market falls, such as with inverse ETFs.
Bottom line
Falling financial markets can lead many investors to feel nervous and fearful. Watching your investment accounts shrink in value is difficult and sometimes leads to panic selling. However financial experts recommend staying invested during a bear market and even say you should try to buy more stocks instead. Following the adage “buy low, sell high” may prove hard when emotions get involved, but history shows it’s a time-proven method to increase your wealth through investing.
