The Dow fell more than 5 per cent this morning, and the S&P fell 3.4 per cent, the worst drop we've seen in a while. Naturally, everyone is freaking out. It's understandable, but don't do anything drastic just yet.
Illustration: Sam Wooley
We've all heard the cliche "buy low sell high", and it's one of those things that sounds perfectly logical on paper. So when the stock market plummets, we log in to our accounts, see our own investments crashing like a drunk driver, and proceed to let fear take the wheel. In short, we panic, and then make bad decisions.
Here's what to know about all the latest stock market crisis, including what you should do about it.
Why Is This Happening?
China's stock market is officially crashing, which is scaring investors all over the world. Monday morning, their own index fell 8.5 per cent, the lowest drop they have seen since 2007. This is due to a few different things, but primarily hinges on the fact that China is dealing with a debt crisis. Banks offered a huge amount of loans to companies during the recession, and this has created a lot of debt, causing the economy to shrink.
There are concerns here in the US too. There's the ongoing uncertainty about whether or not the US Federal Reserve will raise interest rates. Oil prices are dropping, which is great when you're at the pump, but it can be concerning for the economy as a whole.
But the bottom line is, China has the second biggest economy in the world, and their issues are prompting a "worldwide sell-off". Translation: Everyone in the world is freaking out, selling their stock and driving down the market. Ironically, the panic is only making things worse.
What Happens When You Panic and Sell
It's tough to look at your retirement account and see it drained by a thousand dollars or more. At times like these, it's tempting to want to sell all your stocks, mutual funds and index funds, get your arse out of the market and shove your net worth under a proverbial mattress. And when lots of people do that it causes the market to continue plummeting.
These things happen though. It's investing 101: The market goes up, then it goes down. But over time in the big picture, it's always gone back up, averaging a 6-7 per cent improvement over the long term. While people will tell you it's a sign that the market will crash, nobody knows for certain when the market will drop, and the market always cycles anyway.
Days like today are what pros like Warren Buffett are talking about when they say:
Games are won by players who focus on the playing field — not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.
Again, this advice sounds perfectly reasonable, but when the dips actually come, it's easy to lose sight of the long term and flip out when you see your own net worth dropping.
If that isn't enough to convince you not to panic, consider this:
- You haven't actually lost your money. Your portfolio has just dropped in value. You lose your money when you sell. By selling now, you're giving up your chance to let your funds recover (which they very likely will).
- Selling your stock may mean you have to pay taxes on it too. If you have money in a taxable investment account, and you've earned any return on it (even if it's now much less), you'll have to pay taxes on that return later.
- If you withdraw money, you may have to pay a penalty.
So now we're on the same page. Step one: Don't panic.
What You Should Do Instead
We've told you before that buy-and-hold investing is the way to go. That is, you should invest for the long term and not get shaken by day-to-day fluctuations, or even month-to-month ones. A lot of people compare investing to gambling, and when you're actively trading stock day-to-day, sure, it's a hell of a lot like gambling. But if you're properly invested for the long-term, all you should do right now is: nothing. Don't rush to sell all the stocks you own. You probably don't want to pay much attention to them in general right now.
We've told you where to park your savings, depending on your goal. But if you're invested for the long-term, the best thing you can do right now is wait out this dip and hold on to your assets. And you probably don't want to keep looking at how much your accounts are dropping, because that just fuels the panic.
If anything, some ambitious investors even use stock market dips to buy low!
This does serve as a good reminder to keep your portfolio balanced though. Leah Snell, CFP® and Partner at wealth advisory firm Snowden Lane Partners, suggests:
If you have a financial plan and an appropriate asset allocation, stick to it. If you don't, consider doing some research and develop an allocation that is both comfortable and suitable for your risk tolerance in both up and down markets, so that this next time the market has increased volatility, you are better prepared financially and emotionally. Because market volatility will happen again.
If you need your investment money in the next 3-5 years, most of it shouldn't be tied up in the stock market anyway. Now is not the time to sell and rebalance, but it's something to keep in mind for your future savings.
Will It Get Worse?
Sure, those economic issues we mentioned are concerning. Experts are worried about China's economy. We're still not sure about this whole Federal Reserve interest rate thing. And oil prices might be cause for concern too.
But these things happen, and this is a natural part of the process. In fact, it might not be such a bad thing. As Neil Irwin, senior economics correspondent for The New York Times explains it:
It's about time.
That's not to minimise the losses investors have incurred, or to say that each of these moves can be completely justified by data, and certainly not to predict what will happen next week or next month. But if you step back just a bit, what has happened in financial markets this week looks less like a catastrophe in the making and more like a much-needed breather when various markets had been starting to look a little bubbly.
The best you can do right now is wait things out and make sure your portfolio in properly balanced. So will things get worse? The short answer is probably, but then it will probably get better. It always has.