Don’t sell out when markets stress you out

The stock market is going to take a hit. This we can say with confidence.

Will it be a right jab, easily shaken off? Or will it be a full-on body blow that leaves you prone, on the mat, panting, bloodied and humiliated?

A sell-off is coming. We don’t know how severe it will be, what will cause it, how long it will last, or when it will arrive. But history shows that stocks don’t just move up in one, long, endless, elegant line.

So when the correction comes, will you be prepared? Or will you stress out and sell out, doing serious damage to your portfolio’s long-term performance? Here are some tips to help you, umm, roll with the punches.

• Read the series on big investor mistakes:

  • Don’t over invest in Canada

  • Don’t hold too much cash

Understand thyself

The field of behavioural economics is pretty hip these days, ever since Dr. Richard Thaler won the Nobel Prize. Thaler’s research provided the data to prove how “predictably irrational” human beings can be. We behave in ways that are counter to our best interests, and we do it over and over again. This observation certainly applies to how we act in periods of market decline.

One example is called “loss aversion”. This is the idea that people much prefer to avoid losing $5 than gaining $5. When that bias is in force and the stock market begins to fall, it can be very difficult to follow your investment plan.

Spend some time to understand your psychology so you won’t be taken completely off guard when your screen goes red.

Stress test your plan

Some investors have a more pessimistic temperament to begin with. So even if they don’t sell out, they may worry excessively. And that mental strain has its own cost. Doing a stress test will help you understand what you could be dealing with.

You’ve got a basic investment plan….(You do….right? Yeah, of course you do.) So take another look at it and see what happens when there is a significant pullback in your equity holdings. If you have 30 years to go until you need the money, nothing actually happens. If you’re relying on dividend income, and those dividends remain but the stock price falls, again, nothing happens. But if you’re planning to cash out part of it in the short term, a downturn in stocks can be a big problem.

Better to look at some scenarios now so you can see if your lifestyle will be affected when —not if–the stock market stumbles. You might tweak your asset allocation, or just be more aware of the risks you’re taking to get the reward you want. Then, when the time comes, you’ll better able to tune out the media hype, and maybe even put some money to work shopping for some bargains.

Hire some sanity

If you’re concerned about your ability to stay in the ring when the fists are flying, you might want to make sure you’re working with a financial advisor who can save you from yourself. The industry has been under pressure to justify its value, as investors become more informed about fees. This is one big benefit of having a third party on your team.

When the stock market turns negative, it can be very easy to lose your long-term view, waste time and energy worrying, or worse, sell your holdings at the bottom of the market. Remember this: There will be another stock market correction. We don¹t know when, or how long or how bad. Stay in fighting shape so you don’t, umm, throw in the towel.

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• Stocks to help you achieve your financial goals
• Don’t fall for investment porn
• Are you getting value from your financial advisor?
• What Trump could mean for your portfolio
• Protect your portfolio from negative interest rates
• How to drawdown your retirement portfolio
• Do you have the mutual fund adviser six-pack?

About Bruce Sellery

Bruce Sellery is the CEO of Credit Canada, the country’s longest-standing non-profit credit counselling agency. He is a former MoneySense columnist.