How to react to stock market declines : DO’s & DO NOT’s

It’s safe to say 2020 has started pretty rough. The Coronavirus seems to keep spreading, schools, businesses, and even some factories are shutting down. And on top of that, the stock market saw one of it’s biggest declines of the last decades, followed by extreme volatility.

If you have, just like me, most of your net worth invested in stocks, here are some things you should and should not do.

DO NOT

First of all, let’s look at the things you should avoid doing.

1. Panic selling

Try not to panic. This is, of course, easier said than done when you just saw your amount of life savings decline by the thousands. However, it’s important to stay rational and to take an objective look at your investments. If you sell or buy stocks based on your mood, you will not be successful in the long run.

What kinds of investments do you have?

Are you invested in a broad index fund like the s&p500? Congratulations, don’t worry, just go on with your life as normal. Of course, assuming you have been investing with a “dollar cost averaging” strategy. Like described here. Just keep on going with your monthly contributions, this stock market decline will even play to your advantage because you can average down the cost of your portfolio.

Have you been investing in individual stocks? You too have not to panic immediately. Review the companies you have been investing in. Those companies might have seen their market cap decline, however, this doesn’t mean that the company has lost its value. It might take some time, but, usually, a fundamentally strong business will return to its intrinsic value. As rough as the Coronavirus or other factors might have been, usually, your businesses’ competitors will have been undergoing the same negative trends.

2. Panic buying

As bad as panic selling can be, so is panic buying. Suddenly everything seems to be on sale, you start to remember famous quotes as “Be fearful when others are greedy and only be greedy when others are fearful”. However, buying companies when they are cheap is, of course, a good strategy. Nevertheless, as an investor, it’s important to stay rational and to analyze a business well before deciding to buy it. Even the steepest decline in share price can go deeper. So don’t rush in, take your time to find quality businesses and acquire them for the long run.

3. Trying to make short-term gains

Events during a market downturn are very unpredictable. During the second week of March 2020, we had the biggest decline and also the biggest incline of the stock market in recent history. Betting on this volatility would be very speculative. If stocks are bought on the assumption that soon they can be sold for a higher price, you might be stuck with them for a while. Some stocks are extremely overvalued, so even if they fall 20%, they can still be overvalued by 10%.

DO’s

Now you know the watch-outs, let’s look at what you can do during a stock market downturn.

1. Do nothing

Sometimes doing nothing is the best strategy. Charlie Munger, one of the world’s best investors describes it like this: “Investing is where you find a few great companies and then sit on your ass.

With this quote, he doesn’t mean that during market downturns we shouldn’t go after opportunities. What he’s telling us is that you don’t make money by selling and buying all the time, neither by going after mediocre opportunities. It’s often better to be patient and to look for real opportunities. Or like Warren Buffett once said: “What’s nice about investing is you don’t have to swing at every pitch.

2. Accumulate your best-performing companies

Assuming you have done proper research and have been building a strong portfolio, a market downturn can for you be an opportunity to accumulate your best-performing stocks that previously had become too expensive. A declining market can be a great opportunity to average down the cost of your portfolio.

3. Invest for the long term

In the short term, the stock market can be very volatile. Good or bad news, seasonality, and economic trends all have an impact on a company’s share price. This can be easily overcome by investing in fundamentally good businesses for the long term.

This graph of the S&P500 index shows us how volatility matters in the short term. However, people who invested for a period longer than 5 years have still made a profit, even if they decided to sell during this market turbulence.

fredgraph

” In the short run, the market is a voting machine. In the long run, it’s a weighing machine. ” ~ Warren Buffett

So during this market turbulence, it’s important to keep your head cool, stay rational and try to keep your emotions out of the equation.

Though, if during this market decline you need some additional advice about investing and how to handle market downturns, here are some books I can strongly suggest.

1. Charlie Munger, The Complete Investor  ~ Tren Griffin

This book will learn you about value investing and why it’s important to have patience in the stock market. You get to know more about volatility and how to react to it and Charlie will also tell you about his “Sit on your ass and do nothing” strategy.

 

2. The Essays Of Warren Buffett, Lessons For Corporate America ~ Lawrence A. Cunningham

Learn the rules Warren Buffett used for his investments and how to apply them. You learn valuable lessons about some key-metrics and how they can be used in the selection of stocks.

 

If you don’t have the time to read full books, the first book on this list and many others can be found as summaries on Blinkist. Blinkist offers high-quality summaries written by professional authors. The summaries are also available in audio, so you can learn while working out or while being in traffic. It’s truly remarkable how much you can learn on periods where you would normally be scrolling through social media.

 

*DISCLAIMER: The content on this website is made in good faith and I believe it is accurate. However, this content should be considered informational and not for making financial decisions. 

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