What to do when share markets go down

One of the biggest risks to any investment portfolio is the person making the decisions - and, yes, that would be you. Remember how our brains don't like things that make us feel scared and unsafe? In these situations, we choose between fight, flight, freeze and/or fawn - which might be smart for survival, but it's terrible for investing. Because when we see or hear headlines like, "Billions of dollars wiped off share markets" or, "Worst day on the share market in over five years", it can be easy to panic. 

Here's a basic 'how-to' guide for behaving like an irrational investor: 

1. Discover investment markets have gone down. 

2. Immediately panic (and perhaps call others to discuss catastrophic event). Given fear is contagious, potentially infect others with panic. 

3. Log in to your account to confirm it's true, and then gasp. 

4. Stare at reduced portfolio value as your brain confirms it had good reason to panic. 

5. Irrationally decide the smartest thing to do is sell all your investments to avoid the potential of more losses. 

6. Mutter a few choice words as you figure out how to sell down holdings. 

7. Place trade to sell - either at a loss, or for considerably lower than the price was even just a few days ago. This doesn't matter, because you must exit immediately. 

8. Park money back in cash (phew), and shake fist skyward at investing gods for screwing it up. 

9. Tell yourself you never will invest again. (Clearly, it's tooooo risky!) 

10. Keep money in cash and (if it doesn't accidentally get spent) wait for markets to rise again and then say, 'Okay, maybe I will give it one more go'. 

11. Buy back in at a new, higher price. 

12. Wait for the next market dip, repeat. 

This, my friends, is an example of loss aversion. We are wired to feel the pain of losing something (à la money) much more intensely than we feel the joy of gaining something. People tend to panic sell when markets go down because their survival factory setting has overridden their ability to think logically in the heat of the moment. 

Avoiding panic selling - and thinking long term 

Firstly, you haven't 'lost' anything if you don't sell your investment when the market dips - it's just that the value of that investment has decreased. It's a paper loss. (I mean, it's digital, but you get the idea.) The only time it becomes a real loss is when you actually sell the asset. Until then, you still hold the same number of assets. Selling when prices are low and buying again when they are high is, when you think about it, a bizarre yet all too common strategy. 

Diversifying your investments will also help to protect you. If you invest heavily in a single company that goes belly up, then, yes, you've lost that investment. But if that was one of many diversified investments, you can be protected by the others that are still holding strong. 

If you are investing for the long term, you can expect markets to go down at some point. You can reassure yourself this is all part of the cycle and that you have invested correctly for your goal, which is still years away, so it has time to come back and continue to grow. Many of the best days in the share market happen soon after some of the worst. By selling out, you are not only getting out when prices are lower, but you're also potentially missing any gains that may soon follow. 

As an example of this, let's say you invested $100,000 from 2014 in the S&P/ASX 300 for 10 years. Here's how much you would have in total if you held your investment portfolio for the full 10 years, versus what you'd have if you'd missed out on some of the best days on the share market: 

• Invested all days: $213,072 
• Missed 10 best days: $136,594 
• Missed 20 best days: $104,154 
• Missed 30 best days: $83,233 
• Missed 40 best days: $68,289 

Don't wait for the bear 

It pays to make plans to mitigate risk before an adverse event happens. No-one's going hiking in bear country without packing bear spray. So it makes sense to plan ahead with your investments too, right?  

A 'bear market' is when prices of shares or units in other investments drop by about 20%. (On the other side of the coin, a 'bull market' is when prices rise by about 20%.) So if you know the 'bear' is likely to make a visit at some point and that you are likely to freak out when it does, let's get on the front foot and build your own survival plan, well before any signs of its arrival. 

What to do when share markets go down 

If you've invested in index funds with solid historical returns, when share markets go down, in most cases you should do nothing. Remind yourself that you're investing for the long term and that the ups and downs are normal. 

Here are some further tips to help you avoid trading out of panic, stress or even boredom: 

• Go back and review your goals if you need to, so you remember why you invested in the first place. 
• If you need to, take your investing app off your phone (and so make it harder for you to log in and spiral). 
• Consider cutting back on spending and stashing some extra cash into your emergency savings account. This will help you feel like you have more financial wiggle room should anything happen to your income (so you don't need to sell your assets at a time they've gone down in value to pay your bills). 
• Buy instead of sell. If you have additional spare funds that you don't need access to for anything (meaning you have emergency savings and your cash buffer is sorted), you may choose to buy more of your chosen investment product when prices are low. Think of it like your favourite (investment) shop is having a sale. 

Importantly, if you see others panicking, remind them (and yourself) that history is full of examples of downturns and 'crashes'. While markets took a while to bounce back from some of these downturns, history shows they always did. Over the past 150 years, for example, the US market has not only always recovered, but kept soaring to new highs. 
 

This is an edited extract from Get Growing (Wiley, $34.95), republished with permission.