5 tips for how to prepare for investing in a down market
By Allan Leung, Compass and Wealth Lead, ATB Wealth ATB Investment Management Inc. 31 December 2019 6 min read
The sharp upward trajectory experienced in the markets over the past decade has faded the Great Recession of the late 2000s to an almost distant memory. For investors, above-average stock and bond returns became the norm, but expecting that growth to last forever is unreasonable. At some point, the market will turn.
A downturn in the market could be a small dip or a major correction, but both are natural parts of the market cycle. As an investor, being prepared for a down market means understanding what your long-term investment goals are, understanding what your acceptable level of risk is, and sticking with your plan and strategy by returning to more realistic return expectations.
It’s impossible to predict when the market will enter a downturn, but stock prices can go three ways – up, down or sideways. Since investing is a marathon and not a sprint, here we outline some investment strategies and mental models for staying resolute in the face of a down market with an eye on the long-term.
Stocks in the United States have been on a rampage over the last 10 years. How good has the last decade been to investors? The S&P 500, if you go back to the lowest point in March of 2009, has seen an almost four-fold increase.
A decade of growth and low interest rates can lull investors into a false sense of security. But as the saying goes, “past performance is no guarantee of future returns.”
While bullish investors may only see the upward slope and bearish individuals may be bracing for a crash, trying to guess the short-term direction of stock prices is a non-productive, stressful exercise and reactions can exacerbate the downside. If you are selling as the market is crashing, it’s too late. During the market rout of 2009, if investors had reacted to the frenzy that drove up the markets and sold stocks on the way down, they would have overpaid on the way up and crystalized their losses on the way down.
The question “Should we change the portfolio because ‘x event’ is happening?” highlights the difference between short-term tactical decisions versus long-term strategic ones. It’s important to understand that the stock market is more of a barometer measuring investor psychology and sentiment, and sometimes the market chalks up big losses even when the underlying economics are sound.
It’s our job to help investors avoid getting caught up in market psychology and investor bias.
Caused by a rash selling, there’s always a fear of the market bottoming out when stocks take a downturn. Investment bubbles are a perfect example. There’s a sense of hype at first, culminating to peak euphoria followed by a market correction, as investors sell off stocks trying to limit losses. But if you don’t sell, then the losses are just paper losses.
Diversity within a portfolio helps investors manage the major up and down price swings in the stock market. The more concentrated your portfolio is in a few stocks, industries or regions, the greater the fluctuations experienced will be.
In the early 2000s, the price of crude oil was skyrocketing. At that time, investors couldn’t get enough of Canadian stocks. Our approach was to diversify and invest outside of Canada. We managed to avoid big losses when that bubble popped by taking a long-term approach to our investments to look beyond the momentary craze for everything related to Canadian energy in the stock market.
Investing should not be exciting. If it’s exciting, you should be worried.
Investors that tend to do better are those that “set it and forget it,” as this avoids the over micromanaging of an investor’s portfolio. But before this can happen, investors need to create a plan, develop appropriate goals and determine what long-term strategies need to be taken. Creating strong investing habits, which in part is helped by automating your investing process, helps an investor stick to their strategy, even through a bear market or recession, for greater returns down the line.
Building a portfolio is one such strategy whereby each investment you own has a place and complements your portfolio as a whole. For example, depending on how much risk you’re willing to take, this determines the portion of your portfolio that’s invested in bonds and Canadian, U.S. and international equities.
Time will allow you to earn money and smooth out returns, as your portfolio manager makes adjustments. As markets move higher or lower, the portfolio manager will sell and trim investments that have moved higher, and reinvest to those that have moved lower. The strategy is to move money out of stocks or bonds that have moved up in value and reinvest where stocks or bonds can be had for a good price.
If your portfolio is left alone, compound interest should be able to grow the portfolio, it just needs time to work. It’s rarely possible to be able to time the market, as you must be able to time when to get in as well as when to get out. Instead of making rash decisions during a downturn, stick with your plan. Sometimes doing nothing is the best thing you can do. A good investment plan will help carry you through market downturns and, at some point, riding it out is your best tool of defense.
In the last decade, some stocks have grown as much as 10 to 15 percent per year. A more realistic expectation for stock returns is closer to the 6 to 8 percent range. Since we have seen above-average growth over the last decade, there’s no need to panic if that same growth doesn’t continue. I can’t emphasize this enough: reasonable expectations help you stick to your investing plan.
In terms of bear or bull markets, neither is scheduled. There is no set duration or how deep each will get. Sometimes we don’t know that we are in a bear market until we are knee deep in it or even through it.
Sometimes we can tell when there’s overvaluation, like in the 2000 tech market bubble or the 2008 housing bubble. While you can see the overvaluation, it’s impossible to say exactly when that market will turn and the bubble will burst. And selling out might not be the best strategy.
Be in Control
To be successful in investing, pursue your efforts to control what you can control.
Worrying about market down-turns or political events, such as Brexit, are outside of your control. You can control investment costs, asset mixes, the level of risk you are willing to take in your investments and whether you stay invested, while others succumb to fear.
Good investors will recognize the level of control they can exert to remain calm during a downturn. They also see the opportunities these adjustments bring and take advantage by investing when others are fearful.
Finally, they look to the long-term, understanding that the stock market does cycle back and rebound. Then make sure to keep your investment goals in mind; it’s harder to sell when you realize that the losses you are locking in will keep you from retirement or that legacy you wish to leave.