With the recent market correction, I thought I’d write a post about what you should do during a selloff or decline. Keep in mind that this is my personal advice; you should make thoughtful decisions based on your own financial situation and risk tolerance.
First of all, you should identify the extent of the decline. If markets cut down sharply and quickly, then this is probably a correction. Wait a few days, and see what the market is doing. If stocks recover, great – you can keep doing whatever you were doing before. However, if the market has been slowly declining for an extended period of time, or if the market has continued to decline after a correction, then you should start taking action. Take a look at the total economy, such as GDP, jobs, and wages. If these numbers have been growing steadily, then follow Plan 1 (Below). If the numbers have taken a turn for the worse, and the economy as a whole is bad (for example, the recession in 2008), then follow Plan 2 (Below). Finally, if a major global event has caused markets to decline, such as a war or oil spill, then follow Plan 3 (Below).
Plan 1 – Good Economy
If the economy is good and only the market is declining, then you should buy more or hold your current investments. Do not sell unless you absolutely need the money, such as for a surgery or other expenses. If the markets are down but the economy is good, that means the markets were simply overvalued, or they are declining for no substantial reason. While the markets are low, make safe investments in companies you trust. Now is not the time to take risks with small companies. Buy large companies such as Apple (AAPL) and Johnson and Johnson (JNJ). If you have faith in the company and they have consistently made a profit, chances are they’ll recover after the decline is over. Think of the stock as being on sale, only to return to the normal price later. Have caution, though, as there is no guarantee that large companies will return to their old price swiftly, if ever. You can also buy companies you think are undervalued. Some companies decline purely because the market is declining, even though they have a good balance sheet and are perfectly healthy. Buy these companies. A good example is Proctor and Gamble (PG): the stock is currently $79 a share, down 15% from $94. PG has consistently made a profit and has grown sales recently, but the stock is down simply because of the greater market. Buy these stocks while they’re low, as long as you have faith in the company overall. A good place for checking a stock’s value is Morningstar, a company that provides in-depth analyses and reviews of stocks, mutual funds, and ETFs. I strongly suggest you buy a subscription for their service. When looking at a stock on their site, you can see something called “fair value”, as well as buy and sell prices. If a stock is below the fair value and near the buying price, you should consider buying it. PG ($79) is given a fair value of $98 and a buy price of $78.
Plan 2 – Bad Economy
If the economy is bad and the market is declining as a result, then you should hold your investments and consider selling some stocks. Don’t panic and sell everything, but look at your portfolio and seriously consider every stock. You may want to sell riskier companies, such as small-cap and international stocks. In turn, buy solid blue-chip companies or even bonds. Most importantly, diversify your investments. Don’t spend everything you have on one company. Instead, buy an index fund or a bond ETF. In fact, you may not want to buy at all if the economy is doing poorly. Based on the extremity of the situation, consider keeping mostly cash and long-term bonds. Over the long term, stocks tend to increase. However, past results never guarantee future gains, and even the biggest of companies can go bankrupt. Be smart, and carefully consider all your options.
Plan 3 – Major Event
If a major global event has caused the market to go down, such as an oil spill or a war, then you should buy more of the right stocks, and sell the wrong stocks. Let me explain what I mean. In times of war, you should buy defense and consumer staple stocks, and sell any high-risk stocks and non-related stocks. Buy a company that is going to increase because of the global event, and sell a company that is doing to decline. Look at Plan 1 for ideas on undervalued stocks during declines.
In general, you should buy overvalued stocks and sell risky stocks in recessions and declines. Be aware of your financial situation, and do what you feel comfortable with.
Disclaimer: I have long positions in Apple (AAPL) and Proctor and Gamble (PG).