When the Stock Market Tanks (And You Know It Will)

If you're an old-time exchange traded fund (ETF) investor, you've probably been witness to fairly significant declines in various sectors of the stock market. Typically, such declines trigger selling across the board which of course exacerbates the decline. What do you do under such situations?

Bottoms Signal Buying

When things look bleak, I look for opportunities to buy. To keep emotions out of the equation, I simply look at which assets in my portfolio have taken the biggest hit. More often than not, the biggest declines indicate the most panic selling that has little to do with fundamentals. It also means that my asset allocations are probably off. So by buying more, I'm essentially rebalancing my portfolio.

Buying ETFs that look weak can be tough to do. It's much easier to chase ETFs that have recently performed well since it seems more intuitive to believe that past performance is a strong indicator of future performance. This is a flawed belief and often leads to poor market returns.

Of course, as with all things there is a chance that when you buy an ETF at a low point, it could go even lower. In such cases it's only natural to stress about your decision and to even second guess yourself. My experience has been that it's worth waiting without selling to undo your position. The beauty of ETFs is that the underlying securities provide diversification against the risk of a single company going under and taking your portfolio with it.

Caveats

I'm confident in this approach under certain circumstances. First, this applies to ETFs and not to individual stocks. You can't know what's happening for any given company and some companies do go to $0. As such, buying more on the way down doesn't assure a return.

Second, the ETF should represent a diversified holding of companies. For example, just because there's a Gold ETF doesn't make it a good candidate for the sort of buying I'm describing here. Be wary of overly-niche ETFs too such as one that focuses on water companies. And a diversified ETF is one that holds a good number of securities i.e. 50+ so that no single company represents so much of the ETF's value that it's collapse would be difficult to recover from.

Walking the Walk

So what did I do with the last broad-market decline? I bought more. In my case, the emerging market holdings I had were significantly below their highs and below my asset allocation percentages so I added some shares to my existing holdings. Did I consider broader market forces in my decision? Did I look at growth rates around the world? No to both. While an understanding of such things is important, timing the market isn't something I'm looking to do. Or rather, the closest I want to get to trying to time the market is to step in during a significant decline.