When the stock market drops, some investors get antsy. Watching the market decline in real-time can be stressful. It may even seem like invested money is heading towards zero.
During drops in the market, it can be easy for investors to think that their hard-earned money is going up in smoke. A worried investor might reason that it’s better to lose a little now than to forfeit more later by sticking with the markets.
But, is it always a good idea to pull money out of the stock market when there’s a drop? There’s no one-size-fits-all answer for investors, here. (Investors in their 20s, for instance, may likely have different risk tolerance and timelines than those approaching retirement).
For younger investors, time in the market might beat timing the stock market. Here’s an overview of factors investors might think about when deciding whether to keep money in the stock market:
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Investing can be an emotional ride
When markets experience a sharp decline, certain investors might feel tempted to give in to FUD (fear, uncertainty, doubt) — aka, panic selling. Investors could assume that by selling now, they’re shielding themselves (and their money) from further losses down the road.
This logic, however, presumes that the market will continue to go down, which — given the volatility of prices and the impossibility of knowing the future — may or may not be the case.
Focusing on temporary declines might compel some investors to make hasty decisions that they may later come to regret. In the investment world, investors who rush to sell due to price changes are said to have “weak hands.” In a shaky market, having weak hands could lead to further losses.
After all, over time, markets tend to correct. Likewise, when the market is moving upwards, investors can sometimes fall victim to what’s known as FOMO (fear of missing out) — buying under the assumption that today’s growth is a sign of tomorrow’s continued boom.
An emotion-guided approach to the stock market, whether it’s the offloading or buying up of stocks, can stem from an attempt to predict the short-term movements in the market. This approach is called “timing the market.”
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Why time in the market matters
Answering the question of “Should I pull my money out of the stock market?” will likely vary depending on an investor’s time horizon — or, the length of time they aim to hold an investment before selling. Popular opinion generally holds that time in the market can beat timing the stock market.
Put another way, keeping money in the market for a long period of time can help cut the risk of short-term dips or declines in stock pricing. Waiting it out, for some investors, could be a sound strategy.
Many experienced investors believe that it’s impossible to predict something as volatile and unruly as the stock market. Indeed, some investors think that trying to time the market creates higher risks and fewer rewards than keeping money invested in the market for longer periods of time.
An investor’s time horizon may play a significant role in determining whether or not they might want to get out of the stock market. Generally, the longer a period of time an investor has to ride out the market, the less they may want to fret about their portfolio during upheaval.
Compare, for instance, the scenario of a 25 year old who has decades to make back short-term losses with that of someone who’s about to retire and needs to begin cashing out their investment accounts.
Investors who plan on being in the market for a long time, such as young people investing for retirement, may simply want to wait it out. While there is no guarantee that markets will correct in a way that benefits each and every investor, even the sharpest market downturns, with time, can rebound.
Younger investors with long-term investment goals might want to keep their money in stocks during major market routs. But, what other options are available to investors besides pulling their money out of the stock market?
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Alternatives to getting out of the stock market
Some investors might want to stay in the stock market when it crashes, but others may opt to adjust where they’re alloting their investments. Here’s an overview of some alternatives to getting out of the stock market:
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Rotating into safe haven assets
Investors could choose to rotate some of their investments into safe haven assets (like, gold). By rebalancing a portfolio so less holdings are impacted by market volatility, investors might reduce the risk of loss.
Reassessing where to allocate one’s asset is no simple task and, if done too rashly, could lead to losses in the long run. So, it may be helpful for investors to speak with a credible financial planner before making a big investment change that’s driven by the news of the day.
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Having a diversified portfolio
Instead of needing to shift investments into safe haven assets, like precious metals, some investors prefer to cultivate a well-diversified portfolio from the start.
In this case, there’d be less need to rotate funds towards “safer” investments during a decline, as the portfolio would already be split between assets with stability and risk.
Gold, silver and bonds are often thought of as some of the safe havens that investors first flock to during times of uncertainty.
During market turmoil, a significant portion of investors generally move to safe havens (also known as “risk-off” assets). Evidence of this comes from the fact that a market downturn itself is defined by a selloff in riskier assets (like stocks), which can then bring about a rise in value of risk-off assets. In the initial shock, however, sometimes all asset classes see a sharp decline — as people worried about their finances scramble for liquid cash.
One example of this turn to risk-off assets was seen in summer 2020, when the price of spot gold as measured against U.S. dollars had reached new record highs and silver had its best week in 40 years.
During this particular market, bond yields saw several new lows (the price of a bond is the inverse of its yield, meaning the lower the yield, the higher the price).
Investors who managed to shift to these safer havens at the beginning of the crisis may have begun to profit from market uncertainty. And, once trends have been strongly confirmed by the market, it can often create a self-reinforcing feedback loop.
As more investors notice a trend away from more volatile stocks, some will interpret it as a sign of further uncertainty, which could then create more rotation into presumably safer assets.
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Rebalancing a portfolio
Reinvesting dividends may also lead the long-term investor’s portfolio to continue growing at a steady pace, even when share prices decline temporarily. Knowing where and when to reinvest earnings is another factor investors may want to chew on when deciding which strategy to adopt.
(Any dividend-yielding stocks an investor holds must be owned on or before the ex-dividend date. Otherwise, the dividend won’t be credited to the investor’s account. So, if an investor decides to get out of the stock market, they may miss out on dividend payments.)
Sometimes, astute investors also choose to rebalance their portfolio in a downturn by buying new stocks. It’s difficult, though not impossible, to profit from novel trends that can come forth during a crisis.
Acquiring assets that benefit from the circumstances of a market crash may lead to gains. It’s worth noting that this investment strategy doesn’t involve pulling money out of the stock market — it just means selling some stocks to buy others.
For example, during the initial shock of the 2020 crisis, many stocks suffered steep declines. But, there were some that outperformed the market due to recent market shifts. Stocks for companies that specialize in work-from-home software, like those in the video conferencing space, saw an increase in value.
Cybersecurity stocks, similarly, held up due to increased market demand in that sector. Home workout equipment, like exercise bikes, became in high demand, leading related stocks higher. Some remote-based healthcare companies saw share prices rise.
And of course, pharmaceutical companies promising a cure for the pandemic virus saw outstanding rallies, as people believed that a successful product might bring an end to the crisis.
Some experienced investors noticed and took advantage of these trends, but for newer investors or those with low risk tolerance, attempting this strategy might not be a desirable option.
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Assessing asset allocation
During downturns, it could be worthwhile for investors to examine asset allocations — or, the amount of money an investor holds in each asset.
If an investor holds stocks in industries that have been struggling and may continue to struggle due to floundering demand (think restaurants, retail, or oil in 2020), they may opt to sell some of the stocks that are declining in value.
Even if such holdings get sold at a loss, the investor could then put money earned from the sale of these stocks towards safe haven assets — potentially gaining back their recent losses.
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Holding cash has its benefits
Cash can be an added asset, too. Naturally, the value of cash is shaped by things like inflation, so its purchase power can swing up and down. Still, there are advantages to stockpiling some cash. Money invested in other assets, after all, is — by definition —t ied up in that asset. That money is not immediately liquid.
Cash, on other other hand, could be set aside in a savings account or in an emergency fund — unencumbered by a specific investment. Here are some potential benefits to cash holdings:
First, on a psychological level, an investor who knows they have cash on hand may be less prone to feel they’re at risk of losing it all (when stocks fluctuate or flail).
A secondary benefit of cash involves having some “dry powder”— or, money on hand that could be used to buy additional stocks if the market keeps dipping. In investing, it can pay to a “contrarian,” running against the crowd. In other words, when others are selling (aka being fearful), a savvy investor might want to buy.
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Staying the investment course
Attempting to time the market (when there’s no crystal ball) can be risky and stressful. For younger investors, keeping money in the stock market may carry advantages over time. One approach to investing is to establish long-term investment goals and then strive to stay the course — even when facing market headwinds.
Always, when it comes to investing in the stock market, there’s no guarantee of increasing returns. So, individual investors will want to examine their personal economic needs and short-term and future financial goals before deciding if or how to invest.
While managing money during a market downturn might seem tricky, getting started with investing doesn’t need to be stressful.
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