Dow down 4.6%? Don’t panic.

The Dow Jones Industrial Average dropped 1,175.21 points today. It was the largest point drop in the history of the stock market. The index lost 4.6% of its total value. How should investors react to market news like this?

Worst day Dow decline

While the idea of a 4.6% drop in your retirement account can be worrisome, it’s not the largest percent drop in the Dow’s history. The stock market lost 777.68 points in September of 2008, but that was a 7.7% drop. The losses continued, with the market losing almost half its value afterwards.

I worked on the institutional trade desk at The Vanguard Group at the time. I remember it well. I learned a lot about the market that day. The following recession taught me even more. I’ve spent years helping my clients invest. I’ve earned multiple professional financial designations since. These experiences have taught me a fundamental lesson.

The hard work and preparation for a day like today needs to be done well in advance. A fancy education and years of experience will never help you predict the ebb and flow of the stock market. The job of a financial advisor isn’t to predict the day to day market movements. Our job is to plan for your financial goals and to make sure a day like today can’t derail them. Here’s some of the techniques I use to help reduce the losses on days like these:

Diversification

Diversification is spreading out investment risk as much as possible. I have my clients invest in a bunch of similar companies, that way they don’t suffer if one company out of that group fails. I also make sure that they’re investing different types of companies. We’re looking for what is called ‘low-correlation’;. Basically, we want investments that move in opposite directions. For example, the stock market tends to rise at the same time the bond market falls. That’s low correlation.

There is a drawback to diversifying your investments. For financial advisors, diversification always means having to tell clients we’re sorry. A well-diversified portfolio may not have sky high growth, but it doesn’t crash and burn either. When a client tells you that they could have made 25% in the S&P 500 last year, you have to remind them that the same investment would have lost 51% in 2008.

Time frame

Negative market news tends to catch investors’ attention. For years, the only time most clients would call me was on days like today. I would always ask if the needed their money the next day… otherwise, it wasn’t that big of a deal.

Time is the biggest asset investors have. The longer the time between now and when an investor needs the money, the better off they are. If you have a long-term goal, such as retirement in 30 years, the daily movement of the market shouldn’t be a concern. An event like the Great Recession shouldn’t impact your investment strategy either. In the decade since, the market has more than regained its losses.

On the other hand, if you need your money in a few years, it’s time to reconsider the investments in your portfolio. For someone wanting to retire soon, today’s news could derail those plans. As each financial goal approaches, you need to review the risk in your portfolio.

Risk Tolerance

As one takes on more risk, the potential for rewards increases. We know that investing in a small company is riskier than putting your money in a company giant like Coca-Cola. Then again, can you imagine if you put your money in a startup called Google?

Risk tolerance can differ greatly from person to person. The hard part with learning about your risk tolerance is that you’ll only know after you’ve lost money. I’ve seen young men in their 20s think they can go all in with high risk investments only to want to sell out a month later. At the same time, I’ve seen experienced investors in their 60s take chances that I wouldn’t recommend that 20-year-old try.

Understanding how much risk your comfortable with is a vital part of diversifying a portfolio. A diversified, low-risk portfolio will still have high risk investments. However, it’s wouldn’t have the same dollar amount invested when compared to a higher risk portfolio. Building a portfolio that hedges against risk won’t eliminate it, but it will help you reach your goals.

Staying the course

Panicked selling is par for the course on days like today. The market was actually down over 1,600 points during the day. The novices sell, the professionals will either buy or hold. Diversifying your portfolio, establishing a time frame and learning about risk tolerance are all things you can do on your own. Staying the course often requires outside opinions from objective professionals.

As a financial advisor, there’s tricks and tools that I have to understand which investments work best for a client. I know the historical returns of countless allocations. My work helps clients navigate the tax code and minimize the burden. But I have to tell you… where I earn my pay is on days like today.

If another day like today is keeping you up at night, give me a call.

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