How to Survive a Market Decline

Here are some thoughts from the great personal finance book Grow Your Money!: 101 Easy Tips to Plan, Save, and Invest. They give some thoughts on how to survive a market decline (timely topic, huh?) as follows:

• When in doubt, doing nothing is often best.

• Diversification is your best defense.

• Always remember that you are investing for the long term.

FYI, the book was written in 2008, so I don't know if he wrote this before the market meltdown or as it occurred.

Anyway, my thoughts on these are as follows:

• Many people, in their panic and haste, sell at absolutely the wrong time, thus compounding the market's problems by their own foolishness.

• If you have a plan and are invested for the long term, why should you do anything differently? In fact, if you believe in the market/economy in the long term and it's going down now, why wouldn't you buy more, if anything? That's what I did. And the index funds I purchased in the darkest days of the meltdown have done pretty well since then. That said, my net worth isn't where it was in the late summer of 2008, but I'm within 5% of my all-time net worth high, which in part has been aided by those funds I bought when the world was collapsing.

• I think we've all had a lesson the past year in why diversification is a needed part of every investment strategy.

For some additional thoughts on this topic, I suggest you check out 5 Strategies for Investing Properly, Cautiously, and Intelligently in This Bear Market. 

Comments

[Sarah]

If you're selling when the market is down, that's an indication that you took on too much risk (with respect to your life situation) to begin with. Of course, you weren't exactly alone in that mistake. Take it as a lesson on what kind of losses you can actually stomach.

[Lee]

"Doing nothing" historically is *always* the best move. It's also the absolute hardest thing to do, from what I've heard.

I've not had the opportunity yet, but I hope to begin my investment career in the not too distant future. Remember to do nothing... remember to do nothing.. do nothing!!

[LotharBot]

Investing is about getting a good value.

If you don't think you're getting a good value by selling, don't sell. If you think you'd get a great value by selling, sell. In other words, sell high and buy low.

This is opposite what many people do -- when the price drops, they think "oh no, I better sell before this becomes worthless" and lock in losses, and when the price is high they think "this is so desirable I'd better hold on to it" and lose out on the chance to lock in gains. Their problem is that they don't really understand what they're buying or what it's worth, so their emotion takes over, and they buy stuff when it's overpriced and sell it when it's underpriced.

[Craig Ford]

I think these observations have definitely been backed up by the events of the last year. I did nothing through the events of this last year. At times it was hard, but now I can tell it was the right choice.

[rwh]

I've done almost nothing since last year. I continue a 60/40 allocation that in reality hit 50/50 and is now about 55/45. I'm still down about 8% and continue to buy monthly. The only change I made was a couple weeks ago I changed my 14 year old's 529 from Vanguard life strategies conservative to life strategies income. It wasn't scheduled to reset to the "safer" allocation for another 16 months. It had recovered almost all of its losses from the last year and I wanted to preserve capital.

And of course, the market has continued to rise since then.

[LotharBot]

I did a lot since last year, but that's because of the strategy I described above.

Almost all of my holdings were in cash because I thought stocks were overpriced and real estate was WAY overpriced. When the Dow dropped 53%, I thought stocks became underpriced (people were desperate for cash) so I bought into the market big-time. Instead of saying "wow, stocks are down and cash is up, so I should sit on my cash" (the equivalent to "stocks are down so I should sell them") I said "wow, stocks are down and cash is up, so I should get stocks at a discount (the equivalent of FMF's "buy more, if anything".)

Now, I happened to be incredibly lucky -- the bulk of my transactions triggered between March 11 and 16, so I caught it almost exactly at the bottom. But even ignoring that specific timing, virtually everything I bought was with the Dow below 9k, which I think is pretty good value. Now that it's closer to 10k, I think it's at an OK-but-not-great value long-term, and I'm no longer being as aggressive about putting every extra dollar into stocks.

[Super Saver]

FMF,

Congratulations on staying with your investment strategy. Being within 5% of your all time net worth high after the past year's financial crisis is quite an accomplismhment.

[rwh]

My concerns going forward, at least the next year or two are twofold:

Stocks are not cheap right now. According to Vanguard the S&P 500 index fund has a P/E of 22.6. For the total market index it's 26.0. To me that means earnings are going to have to be well above average to sustain that level of pricing. So even holding for the long term doesn't look all that promising.

But with interest rates so low bonds don't look all that inviting either, although if the stock market tanks again my guess is bonds will benefit at least in the short run.

If rates start to rise and the dollar gets stronger, maybe cash will become more attractive, but I don't see that happening anytime soon.

So even with a balanced portfolio, I don't see any obvious upside. What do others think?

[FMF]

rwh --

I think you're spot on for the next year or two, but my time horizon is 15 to 20 years out, so I'm still mostly in stocks.

[Eugene Krabs]

rwh, from a trading perspective, I too am left in a quandry. Even a lot of "pros" out there are saying that there are not a lot of deals out there. Bears can't go short either without significant risk. You really have to look to find your gems in this market.

That said, some swear by the Asian market. China, Hong Kong, Taiwan. If you prefer bonds, I would look into corporate bonds, which still pay a significant return, but you want to make sure you stick with quality.

Passively, it doesn't matter. Just stick to your appropriate risk tolerance and target horizon, and keep on sailing. In fact, passive investors this year should be enjoying a nice run so far.

[rwh]

Well, I have enjoyed a good run so far this year. But even investing for the long term as FMF mentioned, 1996-2009 was pretty long term and a passive investor wouldn't have made anything. The same can be said for 1929-1954.

I realize a good stock picker or market timer can make money, but that isn't me.

So again, with stock valuations high and interest rates as low as they can get, where is the upside for the buy and hold, dollar cost average, passive investor?

[FMF]

rwh --

Check out this post:

http://www.freemoneyfinance.com/2009/09/when-to-pay-off-your-mortgage.html

Some suggestions offered there:

1. Pay off your mortgage (guaranteed return)

2. Municipal bonds

[rwh]

We are currently paying extra on our mortgage. Your site and the state of the financial markets the last year have convinced me we should do this. We could increase that amount, but it would have to be at the expense of what we put in our Roths, the 529s for our kids, and/or our discretionary savings. We are not fully funding the Roths now, only $7200/year total.

I can check with Vanguard on municipal bonds. That's a good tip. Thanks.

My bigger question is why do you think it's a good idea to continue to buy stocks (index funds) at current valuations when you try so hard in most other areas of your financial life to not overpay, everything from your lunch to your house?

[FMF]

rwh --

Because I don't think I'm overpaying given a 15-year investment horizon.

[rwh]

If you bought at these valuations in 1996 you overpaid. That's well documented and that's almost 15 years.

[FMF]

rwh --

Past performance is no guarantee of future results. Besides, I can pick a 15-year period where I wouldn't have overpaid, but we're just playing with numbers at this point.

If you're asking me what sort of investment has a great guaranteed return with little risk, I'm afriad I don't have any answers for you...

[rwh]

But this isn't about past performance, it's about current valuations...........

[FMF]

rwh --

You're using past results to say that buying now isn't a good 15-year plan...

[Eugene Krabs]

I'm a little late to respond, but here's the question: While we know what happened to the market in the last 15 years, do we know what will happen in the next 15?

The past is the past, and we can't do much about it now. It's the future I'm interested in.

Ah, but I think that's the heart of the problem isn't it? Does anyone even know what will happen to the stock market a month from now? Nevermind the stock market, sometimes, I don't even know what I'm going to be eating for dinner two days from now.

We don't know the future. That's the problem.

But what we can do is this. If the markets continue to go up, we can trim back our contributions. If it falls and continues to discount, we should buy more. If you're OK with that idea, well then good news! There's already a passive investment strategy that does just that:

Dollar Cost Averaging.

[FMF]

Eugene --

Just for the record, I don't know what I'm having for dinner TONIGHT. ;-)