Opinion: Follow these 3 critical lessons to weather the stock market storm

1. Recession is not a reason to sell

Are we heading into a recession? A century of economic cycles teach us that we may be in one before economists make the call.

But one of the best forecasters of the economy is the stock market itself. Markets tend to fall before recessions and begin to rally earlier in the economy. As the chart above shows, returns were often positive during the recession.

All points in the upper left quadrant in the chart below are years in which the US economy has contracted but US stocks are still outperforming lower-risk Treasurys. It’s a great illustration of the forward-looking nature of markets. If you’re worried, there are other investors who are worried as well, and this uncertainty is reflected in stock prices.

Whether or not they are accompanied by a recession, periods of market downturn can be worrying. But over the past century, US stocks have posted positive returns on average over one, three, and five years following a sharp decline.

A year after the S&P 500 entered bear market territory (20% down from the previous market peak), it has rebounded about 20% on average. Five years later, the S&P 500 is averaging over 70%.

Fama/French US Total Market Research Index, a value-weighted US market index, from July 1926 through December 2021.

Source: Ken French website

Staying invested puts you in the best position to capture the recovery. If you take risk out of your portfolio, it should be a strategic choice, not a tactical one. The only good reason to sell a portfolio now — as long as it’s diversified and low-cost — is because you’ve learned something about your tolerance for risk or your investment goals have changed.

2. Select the market time at your own risk

When stocks go down, it can be tempting to sell to stop more losses. You might think, “I’m going to sit down until things get a little better.” But by the time the markets are less volatile, you’ll often have missed out on part of the recovery. Yes, it hurts to watch your portfolio shrink, but imagine how you will feel when you are stuck during a market rally.

The big comeback days are hard to predict, and you really don’t want to miss them. If you invested $1,000 in the S&P 500 continuously from the beginning of 1990 through the end of 2020, you would have made $20451. If you miss your best single day, you’ll only have $18,329 – and only $12,917 if you miss your best five days.

History shows that the stock market tends to recover quickly. The same cannot be said for individual stocks or even entire sectors. (How many railroad stocks do you own?) So while investing means taking some risk against the expected return, investors should mitigate risk where they can. Diversification is the most important risk mitigation tool, along with investing in fixed income and having a financial plan.

3. This might be a good time to re-evaluate your portfolio and plan

We’ve seen many fads emerge during the pandemic, from baking to adopting puppies. Have you tried one of the pandemic investing fads – FAANGs, meme stocks or dogecoin? If so, it might be time to put those contraptions in your rearview.

Do you know the names of all the shares you own? So you might have too little. How much of your wallet is outside the US? Because about half of the global market is made up of foreign stocks. If you only invest in the S&P 500 SPX,
+ 0.95%And
You lose half of the group investment opportunities. A global market-weighted portfolio is a better starting point than going after market segments that have outperformed in the past few years.

And if you want to outperform the market, allow decades of academic research to shed light on the way. Portfolios focus on smaller companies, valuable stocks, and companies that are more profitable and have higher returns over the long term. The portfolio I use is invested in over 10,000 global stocks in over 40 countries.

Beyond a well-designed portfolio, one of the best ways to deal with volatile markets and disappointing returns is to plan for it. A financial advisor can help you develop a plan that takes advantage of the chances of experiencing some market dips. They can help you find the confidence to weather the current storm and get to the other side.

The right approach to investing – with a plan, a well-designed portfolio, and an advisor – is the ultimate in self-care during these challenging markets. Your future self will thank you.

Marlina Lee is Global Head of Investment Solutions at Dimensional Fund Advisors in Austin, Texas.