What to do when markets drop

What to do when investment markets drop

By its very nature, investing involves risk. When you invest any sized sum, whether it's into a property, KiwiSaver, or a managed fund, you accept the risks associated with that particular investment. The nature of all investments is that there are constant market fluctuations - peaks and troughs - when investment values rise and fall. However, with nearly all investment markets, values are expected to rise over long periods of time more than they're expected to fall, and this increase in value is why people invest.

Recently, investment markets experienced a fall in values - though many people may not have known about it as there was a royal visit taking most of the media limelight during that same time! So, if you're checking your KiwiSaver balance or another investment value over coming weeks you may notice a drop in value. The next time this happens (because it will happen again!), keep in mind these six things:

1. Stay calm

This is paramount when dealing with a market drop. No one likes seeing their investment value fall, but staying calm and level-headed means you won’t be scaremongered into any snap decisions that may adversely impact your long-term investment strategy and goals. It pays to remind yourself that investment markets are in a constant state of fluctuation – sometimes minimally, other times hugely – but that’s what investing is. It’s riding out those waves in return for long-term gain.

Part of staying calm is also not reading too much into scaremongering media reports, and not checking your investment values too often.

2. Remember your goals

Hopefully, when you invested you used a reputable financial adviser who helped you align your investment strategy with your long-term goals. If you didn’t, it’s advisable to engage one sooner rather than later.

One thing to keep in mind is that if you're withdrawing your investment in many, many years, fluctuations in value today mean little. Even if you've started regular withdrawals already, such as to provide your retirement income, at least some of your investment will likely have to last numerous more years to keep providing you that retirement income.

3. Double-check your investor profile

Are you invested mainly in growth assets (such as shares and property), defensive assets (such as cash and fixed interest), or in a balanced mix of both? The mixture which suits you is called your investor profile.

Double-checking your investor profile every year or so, and every time you have a life event (such as the birth of a child or a change in living situation), is a very wise thing to do. Your investment timeframe - how many years you want to invest for - is one thing that drives the your investor profile, but so do many other factors including the level of investment risk you wish to take, your knowledge of investments, and your capacity to take risks. An authorised financial adviser can assist you with this.

4. Stay diversified

Diversification spreads risk. We all know that putting all your eggs in one basket is risky, which is why the first rule of investing is to diversify. Diversification is the easiest way to minimise the impact of a fall in the value of one type (sometimes called class) of investments.

As an example, the sharemarket in the largest investment market in the world, the United State's S&P 500, was at one stage down 10% during October, but most people wouldn’t have seen a comparative drop in their KiwiSaver investment, retirement savings scheme, or similar investments such as a managed fund. This is because of the significant diversification of such investments.

5. Increase your investment knowledge

Understanding investments and the way the markets operate will give you a higher level of investor confidence and the ability to tackle market drops with ease. Famous American entrepreneur, author, and speaker Jim Rohn deemed that a lack of knowledge about investing and risk was called “the language of the poor”. Essentially, the more educated you are about investments, the better you'll be able to stay in control when the markets drop, and the better off you’ll be overall.

Rohn took this one step further to rightly point out that all risk relative, and that the bill you'll end up paying for not investing is more risky than investing in the first place.

6. Invest more

Frequently, when markets drop, investors panic and try to offload their investments as quickly as they can. This is probably because studies have shown that a drop in prices hurts psychologically twice as much as an equal gain in prices improves your sentiment. But if we understand the way markets work in cycles, then investing more at lower prices can pay off handsomely. In this way, the fear of others can work in your favour. This means that when the markets drop and prices are low it can be the perfect time to invest more.

Or, in the words of the famous investor and billionaire Warren Buffet: "Look at market fluctuations as your friend rather than your enemy, profit from folly rather than participate in it."

The bottom line - what to do when investment values drop

To recap, here are the top six things to do when investment markets drop:

1. Stay calm

2. Remember your goals

3. Double-check your investor profile

4. Stay diversified

5. Increase your investment knowledge

6. Invest more