Humans are hardwired to avoid danger, including financial dangers. This instinct causes many investors to panic and make costly mistakes during periods of market turmoil. A Fidelity study, however, found several positive trends among investors during the recent 4th quarter market correction. It is encouraging to see these trends and, since market corrections occur regularly, it is crucial investors repeat the actions in future market downturns.
- Maintain the investment strategy – Selling investments and going to cash may seem like the safest defense when markets start declining. However, this turns temporary price declines into permanent capital losses. Big mistake. Avoiding permanent loss should be one of investors’ highest priorities. Staying invested through the downturn ensures that the portfolio participates in the eventual recovery.
- Continue cash contributions to the portfolio – The best way to capture the benefits of market declines without assuming the impossible task of timing the market is by continuing regular cash contributions to the portfolio. Suspending contributions is often one of the first things fearful investors do in market corrections. That’s exactly the opposite of what they should do. Consistent contributions take market timing out of the equation as cash is invested throughout the market cycle (i.e., at the highs and the lows). Importantly, the longer the money is invested, the higher the probability that market rate-of-return will be positive. So, long-term investors needn’t worry about the short-term market fluctuations.
- Retain an emergency cash fund – Having an adequate emergency fund is fundamental to investment success. This ready cash should be held in a bank checking or savings account and be sizable enough to cover expenses such as an unplanned medical bill, an unexpected home repair, temporary unemployment, etc. Without this cash, investors experiencing one (or more) of these catastrophes during a market downturn must “sell-low” to cover the costs, locking in a capital loss.