Crash Dummies - The smart way to react to a fall in the market

Between Mid-2015 and Early-2016, most global indices entered bear market territory.

 

Nice little snippet of jargon there. That sentence has been bounced around in the media quite a lot recently. The problem is that many people don’t know what it means and even fewer would have a clue how they should react.

 

The biggest problem an investor faces in tough times is that bad news sells papers. No matter how good the indicators, underlying, and projections may be in some markets, the disaster in another will always grab the headlines. Savers and investors like you and I have to resist the urge to panic and make sensible decisions based on rational thought.

 

The first rule of investing is to anticipate the fact that markets will go up and down. Capitalism needs the boom and bust cycle. Without it, nobody succeeds. If we know that values can and will rise and fall then we can make contingency plans and examine the worst case scenario. Putting safeguards in place through diversification and capital protection should be an essential part of building any portfolio.

 

Imagine yourself as a rock climber.

 

As you look up at a cliff that you are about to ascend, you know there is a risk of falling if you miss a handhold or if the rock gives way. Using ropes, clamps, and harnesses, you can prevent injury in case of a fall. You don’t use safety equipment because you intend on falling, but because you acknowledge the possibility.

 

If and when that fall happens, like a market crash, it can feel sudden and terrifying. Even when the rope snaps tight and catches your weight, you might feel stranded and wonder if the rope can hold you. Now you need to keep your wits about you and think about how to recover.

 

Don’t cut the rope!

 

Retail investors have a terrible habit of selling low and buying high simply because they follow the news. News cycles are delayed by their very nature. If the media is reporting that markets have dropped by 50% then think about why that could be. Is it because capitalism is coming to an end or is it because lots of big investors have pulled their money out? If all of the smart money has been pulled out of the market then you’re already too late. For the same reason, everyday investors often choose to invest in something that has already made a great return for other people or companies and they had heard about after the fact. This is like picking your holiday destination based on last season’s weather. If we know that markets will always go up and down and economic cycles will continue then why would we buy something that has already made great returns for everyone else and sell what those around us have already sold?

 

The key to reacting to big market crashes is simple. Don’t.

 

Take emotion out of it. Be objective. If you have your safety ropes in place, then your question after a fall should not be how much further there is to fall but whether you can now see a better route back up the wall.

 

In recent times we have seen market downturns caused by little more than fear.

 

This is not even a real disaster but simply the possibility of a future problem.

 

Political fears, economic fears, industrial fears, fear of monsters under the bed. It doesn’t matter which. They are all completely natural but ultimately intangible and often irrational.

 

Salespeople, journalists, and politicians play to people’s fears for their own benefit, knowing that human emotion is rarely objective.

 

When people react rashly to a drop in the markets it is often from a fear that what has just happened could happen again.

 

In the meantime, the ‘smart money’ i.e. rational, objective, institutional investors - are exploiting the low prices that were brought about by tumbling values and terrified savers in order to buy up all of the good, safe assets that everyday people have sold off in a panic.

 

If your investment advisor is worth their salt, a big part of their job is to calm your nerves in the bad times and curb your enthusiasm in the good. Long term investing is about recognising market cycles and avoiding gut reactions. Sometimes your portfolio will go up, sometimes it will go down. Take the longer term view and understand that a rash decision now could harm your overall plans.

 

If you’re climbing up that sometimes daunting rock-face towards your own financial summit, secure your safety lines, choose your footholds carefully, and don’t take unnecessary risks.

If you have already taken a tumble, don’t convince yourself there is no way back up.

 

 

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