An Investor’s Guide to the Market Downturn
Concerned about the recent turbulence in the stock market? Use this guide to plan smart steps to help make the right decisions during heightened uncertainty.
EXPERT COMMENTARY | Dec. 2018
Dan Egan | Director of Behavioral Finance & Investing
Prologue, headfake, or detox? What we're confident in for 2019, now.
We know you’ll be skeptical, but 2018 was a pretty average year in financial markets. Normal can feel extreme after the uncanny calmness of 2017. The financial press is certainly excited—news at last. One thing we’re confident of: Negative, sensational articles rarely precede decisions we’re proud of.
Answers to Your Pressing Questions
Before we bury gold bars in the backyard, let’s take a deep breath and consider the future. Looking ahead, we see a few key questions you might want answers to:
- Yet another opportunity to ‘buy the dip’ (for investors looking for comfortable entry points)?
- A prologue to further drops, indicating shorting the market will be profitable?
- The beginning of an unpleasant, but ultimately healthy weaning from low interest rates?
Here, we are confident our crystal ball is cloudy. The economy looks strong, but there is probably still room for improvement in trade and regulation. As investors, we’d like to be invested before those improvements take place, so that we can benefit from a possible lift.
So, as ever, we’ll encourage you to consider how long you are investing for, to remember the tremendous value of your sleep, and to choose a risk level in between complacent and discomfort.
- Make them a relatively attractive compared to domestic stocks?
- Suggest they’ll continue to underperform in the intermediate future?
- Reflect the usual cyclical wins and losses that are the symptom of a diversified portfolio?
This year was particularly frustrating, especially if it was your first year as a Betterment customer. Year to date U.S. markets were flat-ish while international markets were down; in this context global diversification feels like adding insult to injury.
Yet, here we have most confidence in the third question. As we’ve noted before, while the ‘winner’ within a diversified portfolio will ebb and flow over time, a portfolio with many independent parts is typically less subject to extreme failure. We only have to look back at 2017 to see international markets beat US markets by 6%.1
1 VXUS (global ex-US stock market) vs VTI (total US stock market), total annual return in 2017.
Here, we have the most confidence. This is the 10th market drop over the 10 years Betterment began advising clients, and we’ve pulled through them all.2 Focus on your plans, and keep saving. One of the biggest mistakes people can make is to stop saving, rather than just saving into a lower-risk allocation. Consider the following:
- Maintain your savings value: don’t let inflation silently steal from you.
- Focus on your goals, and pick a risk level in line with your time horizon and comfort level.
- Stay diversified.
- Don’t pay more tax than you should. Use your tax advantaged accounts intelligently.
- If you’re going to adjust, adjust a little. The worst decisions are the extreme ones.
And thank you for being such amazing customers.
2 Peak-to-trough drops of 5% or more in the total returns of the ACWI ETF.
Why do market downturns happen?
Market downturns are driven by expectations for the economy, regulation, taxation, politics, and our broader society. There’s hardly ever any one factor we can point to; rather, a combination of factors come together to change markets.
During every stock market drop, you’ll hear numerous explanations why the market sold off, and how you can protect yourself from losses. But usually if you put that advice to work, you’re likely to do more harm than good by locking in losses—not to mention the effect of derailing your financial plans. Here’s how we think about downturns as opportunities for discipline.
Our Advice during Market Downturns
Experiencing Short-Term Losses Is a Part of Long-Term Gains
Far from unusual, downturns are an integral part of even the highest returning investments.
Advice for a Market Downturn: Have a Calm Heart and Clear Mind
Some financial pundits say a market correction is due. Here’s how to prepare yourself.
What have we learned from downturns?
First, keep in mind that short-term losses are an expected part of investing.
At Betterment, we believe that disciplined strategic investing will win out in the long run – which is to say, we see no greater potential loss for the average investor than when they focus on market-timing, stock picking or active trading. As such, we relay the time-tested lessons that we – and long-term investors across the street – have learned:
- Selloffs happen for many reasons, as do rallies. Today’s selloff is not a strong indication that tomorrow it will happen again. Usually, rallies follow selloffs: the stock market goes up on average, after all.
- If you see losses in your account and your first instinct is to make an allocation change, consider the downside of being reactive rather than proactive. Making decisions in the heat of the moment rarely go well. Instead, write out a downturn plan—and stick to it.
- The US capital gains tax structure incentivizes investors to remain in the market long-term, so don’t forget about the money you’ll owe to the IRS if you realize the gains you’ve made.
- Avoid “selling low, buying high” – which happens when you de-risk after a selloff, and take on more risk after a recovery. This is called performance chasing, and it almost never works.
What smart moves can we make during downturns?
Depending on your liquidity needs, risk tolerance, and goal horizon, consider your investments and ensure that the risk you’re taking—which is responsible for the losses, as well as gains, you’re receiving—still fits in with your financial objectives. Keeping the above lessons in mind, there are still some actions you are able to take:
- Revisit your current investment goals at Betterment and your sense of priority for each. You might consider investing more heavily in a Safety Net goal or investing your deposits in a low-risk account, Smart Saver, while you decide how to invest for longer-term goals. Having a known safety buffer can make it easier to stay the course when markets are choppy.
- “Set it and forget it.” This is the advice we’ve given since 2012, which is based on long-standing evidence that panic-induced account changes and monitoring (which happen more during volatile markets) can end up hurting your goals. If you want to be stressed and likely to make bad decisions, monitoring your portfolio more is a great way to do it.
- Tweak your risk level. But make less extreme changes than you adrenaline wants you to. If you zero out risk, make sure to have a re-entry plan, lest you sell low and buy high. For more information on how to balance risk and return, with your liquidity needs, horizon, and risk tolerance in mind, see here.
How Betterment Helps During Downturns
Remember that when we propose your recommended allocation, we have taken into consideration many possible market scenarios that may play out in the future, and arrived at an optimal recommendation for you. Our advice is based on you weathering interim market downturns with the understanding that as you get closer to your goal horizon, you should be incrementally reducing your risk exposure (or we can do it for you automatically). Historical data suggests that customers who follow our advice are more likely to stay on track to reach their goals, even through the chaos of 2008.
How Betterment Helps Keep You on Track Through Tough Markets
Historical data suggests that customers who follow our advice will stay on track to reach their goals, even in a market downturn as bad as the 2008 crisis.