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The Right Questions To Ask When The Market Crashes

Some of you will have had a similar experience to me in the wake of the stock market’s latest swoon.
 
No, I’m not talking about the dizzy fits, fainting and banging the side of your PC thinking the screen must be broken because the share price graph is plunging so steeply from left to right.
 
Sure, we all feel a little bit of all of that, however many times you remind yourself that you’re in it for the long term, and the short-term turbulence comes with the territory with shares.
 
No, I’m thinking about the family and friends who want to know:

  • Why is the stock market falling?
  • Is the global economy going off the rails?
  • Should they sell everything and flee to the hills?
  • Or is this a good time to buy more shares?

If you’re “the investing one” in your social circle then such queries probably sound familiar…

How to be wrong

I don’t mean to make fun of people.
 
For those not experienced in the topsy-turvy ways of the stock market, these questions all seem perfectly reasonable.
 
Indeed, even experienced investors can’t help wondering what’s going on after this sharp stock market reversal.
 
But the fact is these questions – while perfectly natural – are not ones we can confidently answer.
 
Not without a crystal ball or a time machine, anyway.  

  • There are always dozens of competing theories for why markets have fallen, many of which are contradictory.
  • Economists often predict recessions that don’t happen.
  • Selling in a crash is a textbook mistake – unless you’re one of the lucky ones who manage to duck out before further falls.
  • What does “a good time to buy shares” really mean, anyway?

Suffice to say, markets are notoriously unpredictable and pundits who claim otherwise are repeatedly proven wrong.

Just another Manic Monday

To me, short-term market-wide moves usually look more like randomness than anything else.
 
Even if you can find a convincing reason for a particular big fall, you have to ask why it happened this month and not last month, or in three months’ time?
 
Usually the explanations just regurgitate well-known information.
 
Mostly it will be hindsight talking, due to the universal human tendency to want to believe we understand what’s going on.
 
A classic example was the Black Monday crash of October 1987.
 
Major markets fell precipitously and then continued to decline.
 
They ended up down 20-40% in just a matter of days!
 
And everyone had their theories after the event.
 
However, even 30 years on, experts are still debating them!
 
As for the market’s ability to predict recessions… the economy did fine in 1988, and within a year or two most markets had recovered.
 
It was all one big false alarm.

Smarter thinking

What’s much more important than trying to predict the unpredictable market is to know your investing goals, and whether you’re invested appropriately.
 
Here are three better questions to ask when markets fall.

1. Am I invested sensibly for my age and financial position?

Rather than wondering if you should sell up – or whether you should convert your cash ISAs into stocks to bag bargains – I suggest going to a café to think about how you’re invested and why.
 
If you’re young and plan to put money away for decades to come then falls are great. They make shares cheaper to buy for your long-term returns.
 
(Although do remember your other likely financial commitments, such as your mortgage and an emergency fund.)
 
If you’re approaching retirement, you should not have too much in shares. You also need bonds and cash to smooth out the volatility, as you have fewer years of saving to recover.
 
Aged in-between? Your mileage will vary. Read up on asset allocation and the appropriate mix of bonds and shares for your age. Getting that right will probably be much more beneficial in the long run than any attempts to time the market.

2. Am I appropriately invested for my risk tolerance?

Whatever theory says about how much you should have in shares is irrelevant if you can’t sleep at night…
 
…or if you sell up in the middle of a crash out of sheer fear!
 
Ask yourself how have you felt in this correction?
 
Also, how did you respond to the bear market of a few years ago?
 
If such episodes left you feeling vulnerable, take note of that and aim to increase your cash and bond holdings over the next few years.
 
If it’s worse, though – you’re plain terrified – then it’s better to accept you’ve taken on too much risk and consider reducing your exposure. The market decline hasn’t been so bad yet to make this a disaster.
 
Lesson learned. But even then I’d not think in terms of selling everything – or of going “all in” for that matter.
 
Move slowly and stay balanced. Leave the big bets for the gamblers.

3. What should I really be buying?

Let’s say you have spare cash, you’re comfortable with the potential for further falls, and on reflection you want to add more to equities.
 
Good for you – buying when others panic is quintessentially Foolish – but don’t change your focus in the pursuit of the cheapest prices.
 
Some shares and sectors always fall more than others in a slump.
 
That doesn’t mean they’re the ones you should buy.
 
Buying what’s cheapest can be a terrible strategy if you don’t know what you’re doing – or if you do know, but you happen to be wrong.
 
Think of the bargain seekers who kept averaging down into dotcom failures that eventually went to zero in the tech crash of 2000.
 
Or in more recent years, buying apparently cheap small-cap miners and energy firms has been potentially catastrophic as they’ve fallen as much as 90%.
 
Rather than indiscriminate dumpster diving, stick with your usual style of investing. If you happen to get especially keen prices this time around then that’s a great bonus!
 
If you use funds, add to your allocations according to your overall plan.
 
If you’re a stock picker like many of us Fools, forget that list of the biggest fallers and instead favour your watchlist of quality shares that you’ve been tracking for years.

Provided the wider economic factors haven’t changed your view of a particular company’s long-term prospects, this wobble could well be the chance you’ve been waiting for.

A Fool for all seasons

Chasing the market up or down is a mug’s game for most.
 
But taking advantage of the summer sales to buy those shares we’ve always wanted to own is something entirely different.
 
It’s sensible and savvy investing.

Yes, we're in it for the long haul here at the Motley Fool, and we focus on investing in great businesses for years rather than months. It's over that kind of time horizon that we can make sensible judgments on how a business is likely to perform, and whether the price is right.

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