Stock markets continue to move around sharply, and I believe that will continue for some time. A stock market sell-off is an inevitable phenomenon from time to time. I think it is helpful for an investor to have tools to manage such a sell-off to their advantage where possible.
Here are five practical steps I would consider taking in such times.
1. Think for the long term
If a move does not make sense for me as an investor looking at the long term, can it make sense in the short term? The more I focus on short-term opportunities instead of long-term investment cases, the more I become a speculator not an investor.
I think this is always true – but it can be hard to remember during a stock market sell-off. Yet bad decisions I make hastily could set me back by years in building my portfolio.
2. Ignore temptations to bend one’s own rules
The reason I think it is worth developing some investment principles when the market is calm is because one can think clearly then. Applying that approach can bring clarity into an otherwise confusing situation when the market stumbles.
Often a stock market sell-off throws up unusual but tempting situations. Last week, for example, the soaring prospective yield of Evraz as its share price plunged was really attractive to me. But the company does not fit my investment criteria, so even at a more attractive price, it would still be a bad fit for my portfolio. In such situations, sticking to one’s own investment principles can be difficult — but it makes it easier to handle a volatile market in a way that matches one’s own long-term investment goals.
3. Stay diversified
Diversification is an important risk management tool. It allows investors to reduce the risk to their portfolios if a share they own suddenly faces unexpected challenges. Even if I am investing just a few hundred pounds, I can diversify my shareholding across different companies. A stock market dip can hurt most shares, but often some sectors suffer worse than others. That should hopefully affect my overall portfolio less if it is properly diversified.
4. Prioritise facts over emotion
Market volatility – which can coincide with wider political or social volatility – can make for a very emotional time. Other market participants can start talking in dramatic terms, which may affect me emotionally as an investor.
So I find it helpful to focus on facts first and foremost. For example, if someone says “the market for this company will never come back” or “we’ll never see a buying opportunity like this again”, I look at the data. Imagine I do not want to buy a company because it lacks a sustainable competitive advantage, for example. The mere fact of a sudden share price plunge does not change the company’s lack of a competitive advantage.
5. Keeping perspective
Warren Buffett talks about not owning shares that cost him sleep. If a stock market sell-off causes one real stress or financial worry, it could mean it is time to reassess one’s portfolio and investment strategy.
I would build and manage my portfolio in a way that worrying about it does not interfere with daily life. Investing is about building long-term financial security, but not at the expense of my short-term wellbeing.
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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
