What Did the Last Market Decline Teach You About Yourself?

The Questions Investors Should Be Asking Themselves — Part 5

By Brett Carleton, CFP®, ChFC® President & Founder, Heritage Wealth Management

It’s easy to say you’re a long-term investor when markets are going up.

The real test comes when they’re going down.

When your investment account is declining, the financial news is getting increasingly negative, and everyone seems to have an opinion about what you should do next, how do you react?

Do you stay invested?

Do you start checking your accounts every day?

Do you feel the urge to move to cash?

Do you call your advisor?

Or do you start wondering whether this time really is different?

That leads to the fifth question in our series:

What did the last market decline teach you about yourself?

I think your answer can tell you a lot about whether your investment strategy—and your financial plan—really fits you.

Your Risk Tolerance Is Easier to Measure in a Down Market

When markets are performing well, most of us are comfortable taking risk.

If stocks are rising and account values are growing, it's easy to look at a questionnaire and describe yourself as an aggressive or long-term investor.

But that's theoretical risk tolerance.

Real risk tolerance shows up when your money is actually declining in value.

Think about how you've responded during previous periods of market volatility.

Did a 10% decline make you uncomfortable?

What about 20%?

Did you immediately start thinking about selling?

Were you able to continue living your life without worrying about your portfolio every day?

There's no right or wrong answer.

The important thing is knowing yourself well enough to build an investment strategy you can actually live with.

The Headlines Make It Harder

Market declines rarely happen in a vacuum.

Usually, there's a reason investors are nervous.

A recession.

A banking crisis.

A pandemic.

War.

Inflation.

Political uncertainty.

Concerns about interest rates.

The circumstances change, but the feeling can be remarkably similar.

And during those periods, we're surrounded by information.

Turn on the television, open a financial news site, or look at social media and you'll find someone explaining why the situation could get worse.

The problem is that knowing what's happening today doesn't necessarily tell us what markets will do tomorrow.

By the time the news feels comfortable again, markets may have already moved.

That's why I don't believe a successful long-term investment strategy should depend on our ability to predict the next headline.

The Biggest Risk May Be Your Reaction

When people talk about investment risk, they usually mean the possibility that their investments will decline in value.

That's certainly one type of risk.

But there's another one I think investors sometimes underestimate:

The risk of making a permanent decision in response to a temporary event.

Imagine an investor becomes frightened during a market decline and sells stocks to move into cash.

That decision creates another question:

When do you get back in?

When the market falls another 10%?

When the economy improves?

When the news gets better?

When the market reaches its previous high?

Getting out can feel like the difficult decision.

Often, getting back in is even harder.

Now you have to be right twice.

That's why emotional decisions during periods of uncertainty can be so damaging to a long-term plan.

Your Portfolio Should Be Connected to Your Life

One of the reasons we spend so much time understanding a family's financial plan is that investment decisions shouldn't exist independently from everything else.

Suppose you're entering the next phase of life and will need money from your portfolio to support your lifestyle.

If every dollar is invested for long-term growth, a significant market decline may feel particularly frightening.

You know you'll need money soon, and suddenly the assets you're relying on are worth less.

That's why we believe it's important to consider when money will be needed, not simply how much return we hope to earn.

Money needed for near-term expenses may belong in safer investments.

Money intended for goals many years into the future may have more time to remain invested through periods of market volatility.

That doesn't eliminate market declines.

But it can reduce the pressure to sell long-term investments at exactly the wrong time.

A Good Plan Should Prepare for Bad Markets

I don't know when the next major market decline will happen.

Neither does anyone else.

But I do know there will be difficult markets again.

That's not pessimism. It's part of investing.

So rather than trying to predict the next decline, I think a better question is:

If markets fall significantly tomorrow, does my financial plan require me to do something?

If the answer is yes, we should understand why.

If the answer is no, then perhaps the most important action is simply continuing to follow the plan.

We don't build financial plans assuming markets will always cooperate.

We build them knowing they won't.

Think Back to the Last Time You Were Uncomfortable

Here's an exercise I think every investor should consider.

Think about the last period when markets genuinely made you nervous.

Not a small pullback you barely noticed.

A period when you wondered whether you should do something.

Then ask yourself:

What was I feeling?

Fear?

Anxiety?

Regret?

Frustration?

Maybe you were worried about losing everything you'd worked for.

Now ask:

What did I actually do?

Did you sell?

Did you change your allocation?

Did you stop investing?

Did you call your advisor before making a decision?

Did you stay disciplined?

And finally:

How did that decision work out?

The goal isn't to criticize yourself for a decision you made years ago.

It's to learn from it.

Because the next market decline will probably have a different cause, but it may create many of the same emotions.

Sometimes Doing Nothing Is a Decision

We're conditioned to believe that when something changes, we should respond.

If markets fall, surely we should do something.

But sometimes the best decision is intentionally doing nothing.

That doesn't mean ignoring what's happening.

We may still rebalance portfolios.

We may look for tax-planning opportunities.

We may revisit cash needs.

We may confirm that the financial plan still works.

Those are thoughtful responses.

They're very different from abandoning a long-term strategy because markets have become uncomfortable.

Staying disciplined is an action too.

Your Advisor Should Help When Things Feel Uncomfortable

I believe one of the most important roles of a financial advisor shows up during difficult markets.

Anyone can tell you to “stay the course.”

That's not enough.

Your advisor should be able to explain why your plan still makes sense.

Do you have enough liquidity for upcoming needs?

Has anything changed about your goals?

Is your portfolio still appropriate for the amount of risk you actually need to take?

Does the financial plan still work under more difficult assumptions?

Those are the questions that matter.

Sometimes the answer may be that something genuinely should change.

But the change should come from the plan—not from the headline of the day.

Don't Confuse Activity With Progress

Investing can create an unusual temptation.

Because markets move every day, it can feel as though we should constantly be making decisions.

Buy this.

Sell that.

Move to cash.

Get back in.

Chase whatever has recently performed well.

But activity and progress aren't the same thing.

Sometimes frequent changes simply give us the feeling that we're in control.

A thoughtful investment strategy should give you a reason for owning what you own and a framework for deciding when changes are appropriate.

Without that framework, it's very easy to become reactive.

The Next Decline Will Teach You Something Too

There will be another period when investing feels uncomfortable.

We don't know what will cause it.

We don't know when it will happen.

And we don't know how long it will last.

What we can control is how prepared we are when it arrives.

So before the next difficult market, ask yourself:

What did the last market decline teach me about myself?

If your answer is that you took more risk than you were comfortable with, that's useful information.

If you discovered that you needed more cash available for near-term needs, that's useful too.

And if you stayed disciplined because you understood how your investments fit into your larger financial plan, remember that experience the next time the headlines become frightening.

The goal isn't to become someone who feels nothing when markets fall.

We're human.

The goal is to have a plan strong enough that those emotions don't have to determine your financial decisions.

Coming Next: Who Else Is Affected by Your Financial Decisions?

In Part 6 of The Questions Investors Should Be Asking Themselves, we'll move beyond the individual investor and look at the people surrounding the financial plan.

Your spouse, children, grandchildren, aging parents, and other family members may all be affected by the financial decisions you make today.

We'll explore why good financial planning should consider not only your future, but also the people who depend on you and the legacy you hope to create.

About This Series

The Questions Investors Should Be Asking Themselves is an ongoing Heritage Wealth Management series exploring questions that can lead to more meaningful financial planning conversations.

Because sometimes improving your financial life doesn't begin with finding a better answer.

It begins with asking a better question.

Disclosure: This material is for informational purposes only and should not be considered investment, tax, or legal advice. Investment strategies involve risk, including possible loss of principal. The questions and concepts discussed in this article were inspired in part by the work and perspectives of David Booth, founder of Dimensional Fund Advisors and author of Stay Calm. Heritage Wealth Management is not affiliated with or endorsed by David Booth or Dimensional Fund Advisors.