For investors, yesterday’s 1,000-point stock plunge at the market open, fueled by fears over China's shaky economy, may have led to more than a few moments of panic.
Sure, the Dow recovered a bit by the end of the day to finish down nearly 600 points, a 3.6% drop. Still, that loss comes on top of a series of down days that have erased all market gains for the year. All of which raises fears that a bear market will soon follow. For anyone putting away money in a 401(k) for retirement or funding a 529 college savings plan for their kids, it’s enough to make you opt for a nice, safe cash account instead.
Stay chill. Market downturns happen, and after a seven-year bull run, we’re due for a pullback. If you’re a buy-and-hold investor—which is the best kind to be—a dip in stock prices is simply an opportunity to buy more shares cheaply, which will give you bigger gains in the long run.
In theory, anyway. In the real world, market meltdowns aren’t easy to sit through. As reams of behavioral research have shown, investors’ brains are wired to do exactly the wrong thing at times—buy when stocks are high! Sell at the bottom! Poor market timing has typically cost investors more than a percentage point in returns annually over the long term, according to research by Morningstar.
Still, a little planning and mental discipline can help you stay on track toward your goals, while reducing needless market stress. Here are four tips that can help:
1. Consider the long view
“Take a look at your portfolio to see how the actual damage compares to your worst fears,” says Meir Statman, finance professor at Santa Clara University. “Will you really not be able to retire till you’re 97, or is this the financial equivalent of a fender bender?”
For most long-term investors, it’s probably the latter. The Standard & Poor’s 500 stock index has given up 4% year to date. Meanwhile, the market is still up over three and five years. Fixed-income assets have done pretty well too, with the Barclays Aggregate Bond Index returning an average annual 3.1% over the past five years. So if you hold a diversified stock-and-bond portfolio, you’re probably down just 2% to 3% for the year.
Consider too that over decades of investing, you will have to expect more market dips. By the time you reach retirement age, your future self will thank you for staying the course. After all, over the long term, stocks generally outperform all other assets. If you stayed invested in equities since the market hit bottom in 2009, you would be up nearly 300% today. All the more reason to hang tight.
2. Use mental guardrails. The best way to stay on track is to automate your finances as much as possible. That’s the secret to the success of 401(k) plans, which typically auto-enroll workers and place them in target-date retirement funds. That way, you are seamlessly dollar-cost-averaging and building your savings, without even noticing the money leaving your paycheck.
If you don’t have a 401(k), use similar strategies for your IRA or other savings. You can sign up for auto-investing plans at nearly all fund companies and brokerages. It’s the best way to invest, especially when putting more money in the market would seem too scary if you think about it too much. Just make sure the money goes to a well-diversified portfolio that suits your risk level—a target-date fund or balanced fund is a fine way to start. (You can find good candidates on our Money 50 list of recommended funds and ETFs.)
3. Focus on costs, not returns. If you can’t resist the urge to take action, don’t chase the few remaining top-performing funds. Instead, pay attention to things that you can control, like costs. Look for ways to cut your investing fees by switching to less-expensive index funds or ETFs. Reducing your investment costs by 1% could save you some 17% in returns over 20 years, a GAO study found.
It’s easiest to switch funds in a tax-sheltered retirement plan; in taxable accounts you may end up owing Uncle Sam on your gains. Still, you may have taxable losses that you can use to offset profits. Be sure to check with your accountant before making these trades.
You may be able to find cost savings by combing through other parts of your budget. Can you find ways to pay down high-interest-rate debt? That would give you an instant return in a down market. Consider switching to less-costly insurance policies, giving your car a tune-up or changing cellphone plans. Unlike in investing, here’s where a bit of obsessive activity can really pay dividends.
4. Take a walk. Perhaps the best recipe for investing success is to pay as little attention to it as necessary. (That's assuming you have the right portfolio to begin with.) As research by behavioral finance pioneer Richard Thaler found, the more often you look at your portfolio, the less willing you are to take on risk because you see the losses. And as Thaler writes in his new book on behavioral finance, "Misbehaving":
So get away from the screens and go outside. More and more research shows that even moderate exercise, such as taking a walk, has long-term health benefits. As Statman points out, taking a walk is a simple, no-stress way to reduce your future health care costs in retirement, as well as avoid damaging your portfolio.