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How to React to Market Swings

Scott Schuster, CFP®, CPA

Director of Financial Education

Last Updated
May 06, 2022
Man researching market trends

Recent market volatility surrounding discussions on inflation and increasing interest rates has a lot of people spooked. Let’s take a minute to address how you should likely be reacting to these market swings and what actions might be appropriate to take as a result.

Investors generally fall into two camps – those who are building wealth (we’ll call them builders) and those who are protecting existing wealth (we’ll call them protectors).

Builders

These are people often 10+ years from retirement who are regularly saving/investing at least 10% of their income in some way throughout the year, typically through a 401(k) or investment account. When the markets go down, builders should be thrilled as equities effectively go on sale. The decreased share price of stocks means every invested dollar buys more shares for the same cost. As the old investing mantra goes, “buy low…sell high.” Builders should view market pullbacks as a buying opportunity to get more bang for their buck and shouldn’t change anything about their financial behavior.

Protectors

These are people who have already left the workforce or are typically within five years of retirement. They’ve worked hard to amass wealth and are more concerned about safeguarding assets to ensure a long and successful retirement. If protectors have planned appropriately, they should be aware of what’s happening in the markets in case slight adjustments need to be made — but for the most part should maintain the status quo. However, if protectors did not build investment portfolios to withstand market volatility and still provide for lifestyle costs through retirement, they’re likely beginning to panic.

Here are some appropriate actions to take in the face of market volatility:

For Builders

Continue to save and invest as normal. Realize that market downturns will very likely help you to achieve your financial goals in the long run. If possible, consider increasing your savings rate during the temporary downturns to further take advantage of the price discount.

For Protectors

If you’re feeling a nervous knot beginning to form in your stomach, let’s discuss what actions you can take to assuage your fears and help prevent you from making a costly, emotionally charged mistake. Continue down this list until you feel comfortable enough to weather the storm.

Perform your self-affirmations 

If your portfolio was built and is regularly reviewed/updated to address and adapt to periods of volatility, breathe a sigh of relief. Realize that you’re already prepared for a recession or market decline because your long-term strategy was designed with this in mind. Proactively do nothing different. Keep calm and carry on!

Double your cash zero

“Cash zero,” more commonly referred to as an emergency fund, is a threshold we always discuss in our planning conversations. We encourage all clients to keep 6-12 months of spending cash in their checking or savings accounts to create a cushion for any unexpected expenses or life events. By segmenting and maintaining a cash zero, you’re prepared for any short-term surprises that may come your way — you can live your life as usual without having to tap into your portfolio and interrupt your long-term investment plans. The average bear market lasts 1.3 years. If you’re truly concerned about the impact of another market correction, we would recommend you consider doubling your cash zero threshold, which should equal 12-24 months of spending needs. This amount should likely carry you through the majority of an average bear market period without having to tap your long-term investments (and, thus, possibly realizing a loss).

Isolate Planned Capital Expenditures Now

If you know you’ll have a large expense in excess of your typical spending in the next couple of years (e.g., a large family trip, new windows for the home, a new car, education costs, a basement renovation, etc.), earmark needed funds by setting them aside. These expenditures are truly short term in nature and have no business being invested in the equity markets. By carving out these amounts from your portfolio, it should give you the psychological edge of a longer-term perspective.

Align your investment philosophy and investment reality 

This is the difference between “knowing what you have” and “understanding what you have.” If the sticker shock of a drop in the total value of your portfolio makes you crazy, then maybe you should challenge your overall strategy and investment allocation. It’s fairly easy to dial down the risk profile of a portfolio by increasing the allocation to fixed-income investments, which should help to mitigate overall volatility. However, it’s critical that you strive to ensure your future financial independence by maintaining a necessary allocation to equities to provide long-term growth potential. Always remember that your plan is comprehensive and extends well beyond some arbitrary portfolio balance on any given day.

Don’t mistake molehills for mountains

The last time you were on a plane, did you insist the pilot make an emergency landing during a patch of turbulence? The last time you were sitting in gridlock traffic on your way to work and saw a commuter train whiz past you, did you get out of your car, sell it on the spot, and walk to the next train stop? As silly as these examples sound, they aren’t too far off from the behavior of a rattled investor making panicked decisions governed by fear. Market volatility is a normal part of the business cycle, and I can assure you that this time is no different. Eventually, the markets will return to and exceed their prior highs, because that’s what they’ve done throughout history.

When fear drives decisions, mistakes are made. We believe the best approach to combat fear is open and frequent communication around your personalized strategy and long-term plan. We must always remain steadfastly committed to our long-term goals of building real financial independence and continue to invest into properly risk-aligned portfolios.

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This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.

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