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Behavioral Finance

What to Do After a Market Drop

Seeing a market dip is scary. We feel it, too. But it’s important to remind yourself that market drops are an expected, unavoidable part of investing. You may want to take action, but remember: There are productive actions, but they don’t include changing course.

Dan Egan

By Dan Egan
Managing Director of Behavioral Finance & Investing, Betterment
Published: August 24, 2015 | Updated: May 10, 2018

Market drops are an expected, unavoidable part of investing.

Our advice is simple and straightforward: Stay calm and stay the course.

Remember why you’re investing. If you’re saving for a long-term goal, such as a retirement, your allocation already factors in a short-term market drop.

Seeing a market dip is scary. We feel it, too. But it’s helpful to remind yourself that market drops are an expected, normal part of investing. You may want to take action, but remember: While some actions can be productive, making extreme, short-term changes will not help your longer term goals.

A sharp fall in stock prices, as we’ve seen recently, is usually accompanied by scary news headlines and red numbers. Modern media wants clicks and attention, and, unfortunately, fear sells.

It’s hard to stay calm. We feel it, too. But our advice is simple and straightforward: Stay calm and make smart decisions to  support your longer-term goals. We knew there would be days like this, and we planned for it. Betterment portfolios are optimized for your time horizon. They’ll stay that way.

If you’re tempted to take action, remember that this is why we created Betterment—to automatically plan for and handle market drops so that you wouldn’t have to worry about them. When you opened your Betterment account, we based our portfolio-allocation advice on the time horizon for each of your goals. That means each of your portfolios is properly adjusted for risk and takes into account the likelihood and magnitude of a downturn or below-average returns. We’ve planned on seeing some dips, and adjusted accordingly.

Also remember that, as with many things in life, making decisions in the heat of the moment is probably not a good idea. Investing is no different. The more you check your account, the more likely  you are to see losses, and subsequently do something in reaction to a near-term drawdown. And reacting to market drawdowns is likely to  hurt your returns over the long term.

Other Experts Agree: Stay Calm, Do Nothing

You don’t have to take my word for it. Listen to some of the most respected consumer advocates in personal finance.

Jason Zweig, an esteemed columnist for The Wall Street Journal, put together a 2015 list of what not to do. Read it for yourself, but here’s an overview, put more positively:

  • Turn off the news.
  • Stay calm; don’t panic and sell.
  • Use this as an opportunity to diversify.
  • Remember that what matters is the outlook for the future, not a “correction.”
  • Ignore most commentary; no one knows what will happen next.

Ron Lieber of The New York Times knows what this feels like and puts forward six excellent points to consider:

  • You are more diversified than just the S&P 500 and (should) have bonds.
  • This drop is nothing compared to the gains the market has seen in the past six years.
  • These portfolios were constructed when you weren’t anxious.
  • You (should) have plenty of time to recover.
  • If you’re worried about panicking, it’s better to reduce your risk (say, by 20% stocks) than to move to cash. Just know this likely means you’ll need to save more.
  • This is completely normal. This is what markets do.

Cass Sunstein, author of Nudge and an experienced investor in his own right, recommends to “have a diversified portfolio, consisting in large part of low-cost index funds, weighted toward equities; add money as you get it, and diversify it as well; keep the cash you need; and otherwise hold steady (and spend a lot of time with the sports pages).”

Finally, legendary investor Warren Buffett gives perhaps the most concise advice about how risky markets feel, and what you should do: “The stock market is a device for transferring money from the impatient to the patient.”

Stay Focused on the Future, Not the Past

Let’s answer the key question on many people’s minds: How much worse have markets performed after a bad week (a 5% or worse drop in markets) historically?

The answer: If anything, they appear to perform slightly better. Recent performance is simply not informative about what will happen next.

The graph below shows the subsequent returns of the S&P 500, split by if the preceding week was “bad.” We defined “bad” as any week with a loss of 5% or more. We have 48 of such weeks starting from the 1950s. (Analysis from 2015)

Bad Weeks and Future Returns

While it might seem like future returns are more variable after a bad week, this is likely because of the smaller sample size (there are 3,376 weeks that were not bad, for comparison).

Indeed, if anything, it seems like bad weeks are followed by slightly better weeks. But we don’t recommend you bet on it; the odds of it going well are the same as the odds of it going poorly.

Following 4 Weeks’ Return After Normal Weeks After Bad Weeks
< -20% 0% 0%
-20% to -10% 1% 8%
-10% to 0 39% 30%
0 to 10% 59% 51%
10% to 20% 1% 8%
20% or More 0% 2%

What We’re Doing to Help You Reach Your Goals

We’re in an era of uncertainty; we always have been, and we always will be. Even if people say otherwise, no one knows what will happen, so there’s no use in projecting. We understand that it might feel necessary to try to correct what’s happened, but it’s just a distraction. The more important thing to do is focus on the future and staying properly invested.

Tax Loss Harvesting+

Our Tax Loss Harvesting+ can help you capture any losses in your portfolio and use them to help lower your tax bill at the end of the year. You can offset up to $3,000 of ordinary income every year with tax losses, which can be a substantial savings.

Tax-Aware Rebalancing

Each of your goals has its own target asset allocation. We monitor every goal daily, and will rebalance when your goal’s allocation drift passes above our thresholds. This helps to maintain your selected allocation level and buys depreciated assets at a lower price. Rest assured, Betterment will never cause short-term capital gains tax to rebalance your portfolio.

Keeping Your Goals on Track

When your goals start to go off track, we’ll alert you. We may suggest either a one-time deposit or a slightly higher auto-deposit amount to make up for any market losses. However, it’s important to note that most people with longer-term goals will not fall off track.

If You Have to Do Something, Do Something Productive

There are plenty of things you can do in response to a drop in markets that can have a positive effect on your portfolio, risk management, and chance of hitting your goals.

Revisit Your Goals and Plans

A good action to take would be to make sure your goals are properly aligned with your time horizon. For example, let’s take a 30-year retirement goal (target $1 million) with $85,000 rather than $100,000 due to a 15% drawdown. The drop has increased the monthly savings amount to $647, up $10 from $637 before the crash—hardly a game changer. But, that $10 makes a difference over the following 30 years, so check to see if any of your goals have gone off track and need to be replenished.

Opportunistically Deposit to Fund Rebalancing

A market drawdown is one of the most frequent causes of rebalances. The losing assets (often stocks) become underweight relative to the stable assets (bonds). Sell-based rebalances are an automatic and systematic way to buy lower and sell higher. However, in taxable accounts, selling can trigger capital gains and thus taxes, even if the asset is substantially below its all-time high.

Betterment will never cause short-term capital gains tax to rebalance your portfolio. But you can avoid generating long-term capital gains by making opportunistic deposits during volatile times. This allows us to buy underweight assets without selling. On the Portfolio page of your account, you can see the minimum deposit necessary to avoid a sell-based rebalance.

Liquidate Losses in External Accounts

One of the most commons barriers to switching over entirely to Betterment is incurring capital gains in external investments. Take advantage of a short-term market drawdown and let go of an underperforming mutual fund, or diversify away from a single stock position. What can you do today? Prepare a short list of investments you would like to liquidate, and the price at which you are willing to sell them. Our tax-switch calculator can help with that.

If You Can’t Stand the Heat… Turn It Down

While the best investment strategy is usually to stay invested, some people could find the stress simply to be too much. If you think you might make an extreme decision—such as moving to 100% bonds—if the drawdown continues, then it’s OK to reduce your risk temporarily.

Just make it less extreme than you’re inclined to.

Adjust from 90% stocks to 60% stocks, for example. Make sure you set a reminder to revisit your portfolio after a month. While we don’t believe it will improve your performance from a pure investment returns point of view, it means you’ll be less likely to make an emotional decision, and you’ll have a higher return per night’s lost sleep.

Take a Vacation from Your Portfolio

My own research has shown that people are more likely to monitor portfolios during volatile periods. The only problem is that the more you monitor, the riskier your portfolio will seem to you. A better strategy is to log in less during volatile periods. When stress drives bad decisions, it pays to be the ostrich, not the meerkat. When Fidelity looked at which investors had the highest returns, it was those who never logged in.

Still Unsure? Get a Second Opinion

If you have a friend with a cool head, ask her for a second opinion.

Ultimately, the best thing to do in a market downturn is nothing. Our advice takes an underperforming market into account, so trying to correct a drop could end up hurting your returns over the long term.

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