No doubt about it, we've been fortunate to experience generally rising markets for more than a decade now. So it's all the more startling when major turbulence occurs. While there's no way of knowing a downturn's duration, the three guidelines below can help you avoid costly mistakes when the markets seem to turn against you.
1. Have a plan
Whether you're saving for your retirement or a loved one's education, having a plan helps you build in portfolio protection. Without a plan, you're more vulnerable to your emotions, especially during a market drop. You may give in to temptations like chasing performance, timing the market, or impulsively reacting to market "noise"—all in an effort to protect your portfolio by resorting to a quick fix.
Creating an investment plan is easier than you may think. You'll get a good start by answering a few key questions about your risk tolerance, goals, and limitations.
Looking for help with your college savings, but feel you don't have the time, inclination, or know-how to map and manage a plan? If you choose a 529 plan and select an age-based option, your savings will get exposure to all the markets and the investment management will be taken care of for you.
2. Don't fixate on "losses"
OK, so let's say you have a plan, and your portfolio is balanced and diversified across asset classes but its value still dropped significantly in a market decline. There's no cause for panic. Stock downturns are normal, and most investors will endure several of them.
Case in point: Between 1980 and 2019 there were eight bear markets in stocks (declines of 20% or more, lasting at least two months) and 13 corrections (declines of at least 10%).* Unless you sell in a situation like this, the number of shares you own won't fall during a downturn. In fact, the number will grow if you reinvest your funds' income and capital gains distributions. And any market recovery should revive your portfolio too.
Still stressed? It may be time to reconsider the amount of risk in your portfolio. As shown in the chart below, stock-heavy portfolios have historically delivered higher returns, but capturing them has required greater tolerance for wide price swings.
If you're a college saver, you may have less cause to be anxious in a downturn. That's because if you choose one of the three 529 plan age-based investment options (Conservative, Moderate, or Aggressive), you'll get a portfolio designed specifically to help you reduce your investing risk. These options gradually shift from aggressive to conservative as your child grows older and closer to college age, so your risk is dialed back automatically—an especially calming factor as tuition bills come due.
3. Resist rash actions
In times of falling asset prices, some investors overreact by selling riskier assets and moving to government securities or cash equivalents. Or they may embrace what's familiar—perhaps moving from international to domestic markets, in a display of "home bias."
It does sometimes take a market shock to alert investors to the risk in their allocations. For example, you may let your portfolio drift in rising markets, not realizing that you're taking on more and more risk over time. But it's a mistake to sell risky assets amid market volatility in the belief that you'll know when to move your money back to those assets. That's called market timing, and the chart below shows one reason why it's a bad idea.
The futility of timing the stock market.
Its best and worst days happen close together.
Again, college savers who choose to invest in a 529 plan age-based option have an advantage because their savings automatically move through a series of portfolios that become more conservative over time. You don't have to make any changes unless you want to. A 529 plan is the only account type that offers the convenience of age-based options for college savings.
*Vanguard calculations, based on the performance of the MSCI World Index from January 1, 1980, through December 31, 1987, and the MSCI AC World Index thereafter. Both indexes are denominated in U.S. dollars. Our count of corrections excludes those that turned into bear markets. We count corrections that occur after a bear market has recovered from its trough, even if stock prices haven't yet reached their previous peak.