What I Do When The Market Tumbles

Includes: SPY
by: Dirk Cotton

When stocks take a dive, investors call their financial advisors and ask them what they should do. I received a few of those calls this week. Most advisors respond with some version of "Don't panic."

Here's what I do when the market crashes: nothing.

To be completely honest, I wasn't aware that the market had fallen 8% so far in January until my wife told me late this week. I don't watch business news - life is too short. She picked it up on CNN while she was watching election news. (I don't follow that, either.)

Here's my theory. If you have such a high allocation to equities that market declines make you anxious, you own too much stock. Find the allocation at which severe bear market losses won't keep you up at night.

In the 2007-2009 bear market, the S&P 500 fell over 50%. My portfolio fell just 15% because I had a 40% equity allocation. As one of my favorite baristas, Mandy, would say, "It didn't feel totally awesome." On the other hand, I didn't lose sleep.

William Bernstein addressed this in a couple of his early books, including The Four Pillars of Investing (page 268). He suggests that the initial pass at the correct asset allocation for you be based on how much you can tolerate losing in a bear market. He provided the following table:

I can tolerate losing
this percent
in a bear market
Invest this
much in stocks
35% 80%
30% 70%
25% 60%
20% 50%
15% 40%
10% 30%
5% 20%
0% 10%

Every December I evaluate my finances and plan for the coming year. I calculate my desired asset allocation, which might not be the same as last year's. If my current allocation is within an absolute 5% or so of my desired allocation, I do nothing. Otherwise, I may trade a few funds or ETFs to implement my new allocation. In reality, this rarely happens because my allocation doesn't often stray very far.

Because I am willing to lose 15% in a severe bear market, I don't labor over my portfolio value daily. I probably check it four times a year, at most. I retired to enjoy the remainder of my life, not to fret over the stock market.

Here's some advice from other advisors I trust. Wade Pfau suggests reading this piece in the New York Times entitled, "6 Tips for Investors When the Stock Market Tumbles." It's a good one.

Dana Anspach suggests that if you feel that you must do something, instead of selling stocks, enroll in her free online class on retirement - another great idea.

Joe Tomlinson and I provided suggestions in Robert Powell's USA Today column, "Advice for investors during crazy stock market volatility."

If you're retired or plan to be soon, set your asset allocation to a level of equities that you can tolerate. By definition, that means you won't feel the need to do anything at all when stocks tumble. For young people still accumulating savings for retirement, invest most of your portfolio in stocks and don't you do anything, either. In fact, do less than nothing. Time will fix this for you. As I recall, the 22% loss on a single day on Black Monday in 1987 didn't feel totally awesome, either, but now it is barely a blip on the history of the S&P 500.

So, here's my advice: pick an allocation you can stomach and ignore the noise. If you owned too much equity this time, gradually adjust it downward.

You'll know you're at the right allocation when the market takes a dive and you don't feel a need to call me.

Oh, and don't panic.