- The golden rule of a down stock market
- How diversification can help protect your portfolio
- What to do when the news predicts doom and gloom
Markets rise and fall, like the tides of an ocean. It’s in their nature. When investing, we always hope for a market that is trending upwards. But what happens if you’re looking to invest when the markets are sinking?
A rising tide lifts all ships, but, as Warren Buffet has been famously quoted, “only when the tide goes out, do you discover who’s been swimming naked.” What Warren is trying to tell us is that when the market is climbing, everybody is making money. However, when the market slows, we see who’s prepared for the dip.
So if the tide seems to be going out, what can you do to keep yourself covered?
The golden rule: Don’t panic
The market will have its slowdowns. And while everyone navigates a market downturn differently, ‘don’t lose your cool’ is a pretty universal first step.
What if one or two big-name stocks are plummeting?
The poor performance of a single business—no matter the name—doesn’t necessarily reflect the market as a whole. It doesn’t even always mean trouble within the sector. For example, when a number of retailers ran into trouble around 2017, it wasn’t because their markets disappeared. It was because customers were taking their business to other retailers.
If you’re concerned about a drop of a struggling stock in your portfolio, do your due diligence to figure out why the price is falling. You may need to take action, but you want to make an informed decision and not a knee-jerk reaction.
What if the TSX is down? Doesn’t that mean everything is down?
The TSX index is an accumulation of all 1,500-plus Canadian stocks listed on the exchange, across every sector. However, due to Canada’s natural resources, a major chunk of the value consists of the mining sector, the energy sector (gas and oil), and the banking sector. Since these represent a large part of the capital in the Canadian market, those industries can skew the TSX’s overall performance.
The TSX can also be influenced by larger events that have nothing to do with the listed companies at all. This recently happened when the Bank of Canada raised interest rates. When the rates were raised to 1.75% on October 24, 2018, the TSX saw its worst day in 3 years. However, within two weeks, it was back to where it had been before the rate hike.
The ‘TSX ticker’ you often see on news sites is actually the S&P/TSX Composite Index. This index only tracks the largest companies in the TSX, and is ‘capitalization-weighted’, meaning larger companies have a much greater influence on the index than smaller companies. For example, if the largest indexed company’s stock drops in value while several smaller listed companies’ stocks rise, it still might show up on the S&P/TSX as an overall drop.
As you can see, indexes can be a helpful tool to give a rough sense of how a group of stocks are trading, but they are definitely not a comprehensive representation of every single stock or portfolio in the market.
What if the market keeps going down?
If the market continues to drop, or if it drops significantly in a short time, then it could indicate a recession. If this is the case, take a deep breath and remember the golden rule:
Though history isn’t a guaranteed predictor of the future, it’s worth noting that since the 1940s (when laws and policies were introduced to prevent another Great Depression), the market has recovered in under 10 years—and in smaller dips, it historically rebounds in under a year.
The correct course of action may still be to sell, but the decision should be made with a level-head, not out of fear that the market is going to keep falling forever.
In times of recession, panicked long-term investors can be tempted to ‘play the market’ by trying to sell their portfolios when the market is falling, and buy back when it starts to rise. Unfortunately, there’s no way to say what the market is going to do. An attempt to play the market could result in selling right before a stock climbs, or buying on a ‘bounce’ (a small, temporary gain) in the middle of a stock plummet.
Whether you want to play the market or play it safe, make sure that you do so with a level head.
When in doubt, you can always diversify
We’ve all heard the term “Don’t put all your eggs in one basket”. In the stock market, the term is as close to literal as you can get: If you put all your money in one category—be it a single stock, a single industry, or a single region—then one drop of that basket can do some serious damage.
The remedy for this is diversification. Spreading your investments across multiple industries can greatly reduce the damage the drop of a single stock/sector/region can inflict on your portfolio.
For example, pretend that a major government decides to place tariffs on fish coming out of Greenland, causing their fisheries’ stocks to drop in value by 50%. If you had invested entirely in Greenland fisheries, your portfolio would drop by 50% as well. On the other hand, if your portfolio was spread evenly across 20 different categories, a 50% loss in one company’s value would only cause a 2.5% drop to your overall portfolio.
Exchange Traded Funds (ETFs) can be a simple way to diversify. They’re securities that are traded on a stock exchange, but instead of representing a share of a single company, they track an entire group of stocks. Some ETFs focus on a single industry, while others are designed to be diversified across several markets.
Finally, you could always consider a robo-advisor, which uses a computer algorithm to automatically diversify your portfolio. Of course, if you’re considering a robo-advisor, you’ll definitely want to look at Questwealth Portfolios. Unlike most robo-advisors, Questwealth Portfolios are actively-managed by expert portfolio managers, adding the expertise, insight, and oversight of a skilled human while keeping the cost-efficiency of a computer algorithm.
Some investors choose to get defensive
When some investors think they’re facing a slow market, they start to invest in companies that provide products and services people will still buy during a recession. These defensive investments can still fluctuate with the market, and may still fall in value during a recession, but if your assumptions about their performance is correct, then they could prove much more stable in a recession than less defensive stocks.
Of course, there is a trade-off to defensive stocks. Stability is a double-edged sword when it comes to investment: A stable stock may not fall as far during a downturn, but they tend not to gain as much when the market is strong. This can make defensive stocks less profitable when the market once again starts to climb.
So what should you do when the markets are down?
If there were a ‘magic bullet’ to guarantee profits in a down market, then the market would never be down. There are some techniques that advanced traders try to use in a downturn, but these tend to carry high risks with them. There are other advanced techniques to mitigate losses, but even these can be short-term solutions and a bit of a gamble.
The one thing everyone should do when the markets are down: Don’t panic.
Keep a level head, weigh your options, and try to make the most informed decision that you feel best suits your goals and risk tolerance.
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The information in this blog is for information purposes only and should not be used or construed as financial or investment advice by any individual. Information obtained from third parties is believed to be reliable, but no representations or warranty, expressed or implied is made by Questrade, Inc., its affiliates or any other person to its accuracy.