What to Focus on During a Market Selloff

What to Focus on During a Market Sell-Offs

 
On days like today, the markets test your mettle as an investor and a reminder that the prolonged period of low volatility and easy returns, such as 2019, are earned with periods of volatility. The markets usually move slowly up but violently down in times of panic. While the coronavirus is quite scary, the financial markets are trying to predict how much the world’s economy is going to slow down and the possibility of a global recession. The economy is likely to temporarily slow, but perhaps significantly, as people hunker down, work from home and go out less as they wait out for the economic impact to pass. The energy, travel, leisure, dining, retail and business travel sectors will all suffer from decreases in revenue and profits. Historically, pandemics are transitory, lasting weeks or months but likely not years; and as such, should be seen as an opportunity in part of your long term investment strategy.
 
Days like today and the last two weeks are times to remind us of the following six principals:

1. Don’t give in to the panic: It is almost impossible to try and time the market. You can’t have the up without the down. The 25 best days in the markets are frequently clustered among the 25 worst days. The markets are forward discounting instruments and are always predicting future outcomes. In times of panic, they are predicting prolonged slowdowns, and in times of prosperity, they are predicting the “party” to continue. The markets can fall prey to the same pitfalls as human emotions. Market selloffs can be emotional and trigger panic responses. In an environment like this, it is crucial to have a plan and try to remove emotion from your decision making. Doing so can be hard, even for the professionals, but panicking and letting your emotions control your decisions on the fly in such a volatile environment often results in decisions you will regret when you look back in hindsight.

2. Assess your risk tolerance: A financial crisis may not seem like the best time for you to assess your risk tolerance, but it is probably the best time to take a good look at your portfolio and the mirror. If you need cash flow from your account, have you put enough aside to withstand the whipsaw in the financial markets? Have you overestimated your risk tolerance when the market was strong? It is human psychology to be too optimistic during positive when the markets are strong and too pessimistic when markets are negative. This creates the bull and bear cycle in the markets. A market crash is not a good time to do a full rebalance of your account but when the markets do recover, it is time to rebalance to a more suitable asset mix that you can maintain throughout the volatility over a long time horizon. 

3. Remind yourself of your time horizon: Most investment time horizons are measured in years, not days, weeks or months. It is essential to remind yourself of this and not get caught up in the market hysteria. For example, retirement in 2020 is often last up to 30+ years, not a single event where all of your securities are liquidated the day you retire. Your nest egg is designed to provide years of cash flow to fund your retirement. If you are financing a purchase of a house in the next six months to a year, you should have already started to move a large percentage of your assets to cash or short term investments, which can be used to fund your purchase.

4. Why it is important to own diversified portfolios: While in times of volatility, the financial market’s correlation increases, not all securities will move the same. By not being overweight in any single stock, helps to reduce the risk that an individual security can destroy your portfolio. Market volatility is also a reminder never to be 100% in equities. The risk-off portion of your asset allocation – comprising of fixed income and cash has done its job since the stock market’s peak. These segments of your asset allocation are there to play defence for you and a source of funds that can be used to fund short term cash flow needs and capital that can be used to rebalance and purchase securities that have gone on sale.

5. The reason why we use conservative estimates for financial planning purposes: shocks to the financial system are often exogenous and unplanned. When you are making your financial plan, it is essential to try and include these types of shocks into your calculations, but this is hard to do as you can hardly predict the timing or magnitude of these moves. When building a financial plan, it is important to try and incorporate these unknown shocks. One way to do this is by looking at the historical returns that have included previous external shocks to help create a conservative return projection for the plan.

6. Focus on what you can control: In a market decrease, it is crucial to focus on what you can control and to be proactive. Market sell-offs are a great time to buy companies that have gone on sale and create a base for future growth. This can be done by:

• Increasing your regular contributions to your RRSP and TFSA, or set up a monthly contribution plan if you have not done so already.

• Institute a dividend reinvestment plan to use the dividends to purchase additional shares, which helps by buying more shares of your investments at lower prices instead of sitting earning nothing in cash.

• Use this opportunity to purchase high-quality companies that you may have missed on the way up; often, then the markets decline, the good is thrown out with the bad and can provide an opportunity to add good core positions.