Q18: What should I do when the stock market falls?

Stay calm and let the journalists overreact

Since October 2018 the Australian stock market has had what the market pundits like to call “a correction”. At the time of writing, the main Australian Stockmarket index — the S&P/ASX 200 — is down almost 10%.

Don’t fall for scary headlines like this

So, what’s a sharemarket investor to do when faced with a downturn like this? Here at The Money Question we’d say “Nothing”. Here’s why.

It’s what you wanted

Remember that when you invested in the share market you did so because you were looking for a higher return. Remember also that in our first post we discussed at length the unbreakable link between return and risk: you can’t have more of one without also getting more of the other. That higher return translates, of course, into an increased possibility of just the sort of market correction we have seen in the last few weeks. 

It happens a lot

A correction comes around roughly every three years. It’s just part of the general economic cycle that is typical of the way the economy develops. Share investors should know keep this in mind to avoid any surprises when the inevitable downturn occurs.

You’re selling low

In order to make profits you buy shares at a low price and sell them at a higher price. When markets fall there’s an understandable reaction among investors to sell. Stop and think how counterintuitive this can be; by the time you’ve made a decision to sell the market may be down 10% or more. What’s the benefit in selling if prices have fallen? The natural tendency to run for the sidelines when markets get choppy can cause investors to make avoidable mistakes, to pay unnecessary tax and to incur costs that erode their profits. 

You have a diversified portfolio 

Scary stories about market downturns make great newspaper headlines.  TMQ is all about diversification so downturns in one market shouldn’t be the death of your whole portfolio. That’s the point of holding a diversified portfolio of investments.

Shares are a long-term investment

Market downturns, as we said, happen regularly. Some are worse than others. Chart 1, below, shows the movement of the Australian sharemarket’s Top 200 stocks since November 1992. You can see the market moving around the long-term trend (which is definitely upward-sloping), sometimes quite a lot. The Global Financial Crisis of 2008 is a prominent downturn but, in the ten years since the market has performed strongly.

Chart 1: Australian Sharemarket since 1992
The long-term trend is “up”

It’s important to remind yourself of the long-term nature of an investment in shares. A downturn lasting a few months is a blip on the long-term goals which an investment in shares aims to fulfil. Keeping this front of mind will help you to ride out the regular downturns that are a part of a sharemarket investment.

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