Responding to the Recent Stock Market Decline
Posted by Rick Miller on February 12, 2018
You may have heard that the stock market has been very volatile recently, with several days of significant declines. The drops in the US market on Monday, February 5th and Thursday, February 8th were especially large, around 4%, depending on the index. This followed a decline on February 2nd of a bit over 2%. To add a bit of interest, on February 5th the Dow Jones Industrial Average was down more than 1100 points, a record (February 8th’s decline was no slouch, over 1000 points). With some intervening increases, the US stock market was over 8% lower than it had been the week before.
International stock markets also declined.
The news media, both financial (such as the Wall Street Journal and Financial Times) and non-financial, such as the New York Times, NPR, and Fox News, talked about “plunges” in the market, and “extreme volatility.” Should you be worried? Should you do anything?
First, let’s place the news in context:
- As we have said in many of our discussions with you, stocks are risky assets. Because they are risky, they can offer, but do not guarantee, higher returns than less risky assets. Risky means that losses will occur, sometimes over the course of days, sometimes over the course of years. The recent stock market declines are, unfortunately, just the latest evidence of that fact.
- One reason these recent declines have had such powerful emotional impact is that stock markets have been rising steadily since their last sharp decline in late 2015. More broadly, some say that we’ve been enjoying a bull market since the end of the Great Recession in 2009. We have gotten used to rising markets, and we’ve conveniently forgotten that stocks are risky.
- Despite the recent declines, US stock indices were only about 3% lower at the close of business yesterday than they were at the beginning of the year, and are still well above where they were at the end of 2016, 2015, 2014, 2013, and in fact, at the end of any other previous year.
Second, let’s consider other economic news:
- The US unemployment rate is very low – more people in this country have jobs than even a year ago.
- US wages are rising – people with jobs are earning more.
- The US economy is growing steadily.
- The European economy is continuing to grow.
- The US Federal Reserve is beginning to wind down the extraordinary measures it adopted to counter the Great Recession.
- In summary, the economic news is broadly good, and nothing about the recent stock market gyrations changes that.
Finally, let’s consider your situation:
- Your financial plan should not rely on stock market performance for you to be successful.
- You should identify a portfolio allocation (using your lifetime financial plan and balance sheet) that is consistent both with
- Your risk tolerance, which
- Rises when then stock market rises; and
- Falls when the stock market falls (discomfort is contagious – you feel less confident).
- Your risk capacity (the amount of risk you can afford), which changes little if any when the stock market declines.
- Your risk tolerance, which
- In rising stock markets, regular rebalancing to your target allocation will ensure that your risk level is always consistent with the amount you can afford and stomach. You can (as we do for our clients) invest your dividends and cash contributions largely in bonds. If you have followed that practice, it is very likely that you have more bonds, the more stable asset class, than you did a year or two ago.
- In short, while it’s unpleasant when your portfolio goes down, your well-being should not be threatened.
Large reductions in stock market values coupled with inflammatory language in the media can be very disconcerting.
A lifetime financial plan and a savings strategy and investment portfolio designed to accomplish that plan enable you to maintain your equilibrium when markets are turbulent.
Rick was also quoted on the subject in a recent article in the Christian Science Monitor.
Rick Miller is the founder of Sensible Financial Planning and Management. Got a question for Rick about the stock market? Ask in the comments section below, or get in touch with us via email.