How to Invest in a Falling Market

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Jason’s Random Words: 3 steps to success in a down market

I’m a big reader. One of my favorite book series of all time is The Hitchhiker’s Guide to the Galaxy. In the story, the protagonist, a man named Arthur Dent, finds himself in strange, unpredictable, at times scary situations. But as he is also in possession of a copy of The Hitchhiker’s Guide, all he has to do is look at the cover of the book for an important reminder of where to start in these situations.

We all would love an Investor’s Edition of the Guide right now. After a good Friday (it came a couple weeks early this year…. I kid!) the S&P 500 is down around 8% from the high following a temporary dip into correction territory on Thursday. The tech-heavy indices have been down more than 10% for a few days and remain down that much still. The market is always forward-looking, and it largely does not like what it sees.

The thing is, the economy isn’t really in that bad of shape. Employment remains strong. Inflation isn’t as low as the Fed wants, but it’s not wrecking the economy. The housing market is still a mess without enough inventory, but there’s plenty of pent-up demand and homebuilders are trying to meet as much as they can. I could add more positives, and also point out a few concerning factors (including many of the things the Trump administration is doing that, wherever you stand on them long-term, there will be short-term pain if things continue apace) but the point is, it’s not terrible out there as our pal Lou Whiteman wrote yesterday.

Lou also had some solid suggestions for how to think and act in the current environment. So do I, in three simple steps.

Step 1: Don’t Panic

Seriously. You have to start here. Take a step back. Take a deep breath. Don’t rush your decisions. Us small-money, retail investors don’t have many advantages, any speed definitely is not one of them. Chances are, acting quickly is reacting to the market, not making meaningful decisions based around your financial needs and goals.

Step 2: Work your plan

You have financial goals. You know when those goals are. Act in the interest of reaching those goals. If they’re near-term (for me this is within a few years, your mileage may vary) consider if the volatility risk of stocks is too great and holding cash, CDs, etc., makes more sense (pro tip: Almost certainly yes). The further out those goals are, stock selloffs become something between benign and an opportunity.

The main thing is that by defining your goals and when they are, you can appropriately allocate capital to assets that are aligned with these goals and avoid wealth-destroying mistakes like selling stocks you won’t need to touch for many years just because the market is falling, or holding stocks that you should have already turned into cash right into the next market crash.

Step 3: Don’t try to get it perfect, but be ready to act when there’s opportunity

Peter Lynch is known for saying that more investor money has been lost waiting on the next crash than in all the crashes combined. His point is that the opportunity cost of waiting for a big crash is usually higher than the benefit of waiting. This is because the market goes up about three of every four days, and ¾ of years, too. When something good happens 75% of the time, waiting for the bad thing to give you a better opportunity just isn’t worth it.

But! A 10% market selloff isn’t as rare as the big crashes; we actually get one a little more than two our of every three years, and it’s worth taking advantage of them. They are meaningful enough that for me, a 10% selloff triggers one of the few rules I have: I have to buy some stocks when the S&P hits correction territory.

I actually chose to do some buying before that this week, adding to some of my favorite homebuilder stocks, which have fallen by more than one-third in the past several months, on Wednesday. I think there are plenty of other opportunities out there, too.

But I’m also not naive to the possibility that the stocks I just bought could continue to fall more, and stay down for an extended period of time. I didn’t make these investments looking for a quick buck. I don’t own them with money I’ll need in the next decade, much less the next few years. And I believe that when I do need to start turning them back into money, they’ll be worth considerably more than the dollars I invested.

Jason