What should I do when share prices drop?
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
Have you ever experienced the urge to “panic sell” when the stock market goes down? It can be deeply uncomfortable to watch your investments fall 10%, 20% or more in a short space of time. Yet is selling them (to avoid further losses) the best idea?
Below, our financial planning team at Castlegate in Grantham show why stock market prices sometimes go down, and what to do (in consultation with your adviser). We hope you find this content helpful. If you want to discuss your own financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
Why do stock prices go down?
One benefit of cash in a savings account is that you can be almost certain of its value tomorrow. Cash does not fluctuate like the stock market. However, the downside of cash is low – or even negative – returns, due to inflation. If inflation stands at 3% but your cash account generates a 0.5% interest rate, then in real terms you lose 2.5% over time.
To access better returns, investors need to consider other assets like the stock market. Yet here, the investment risk is higher because company valuations go up and down. The reasons for this volatility are numerous, but prominent ones include:
- A breakout news story. Publicity – such as a government fine – can lead a company stock price to fall. In 2010, BP’s stock value fell dramatically after the US government issued a fine over the Gulf of Mexico oil spill.
- Market sentiment. Stock prices are heavily driven by how most investors feel about the overall economy and market outlook. A particular company may have great financial statements, for instance, but if investors sense a pending market crash then they may abandon the stock for “safer” assets – leading to a falling price.
- Technical factors. Suppose a company split its stock from $100 to $50. Here, the total enterprise value is not changed by the stock split (since there are double the shares), but investors may be prompted to buy/sell based on the new price.
- Fundamentals. If there is growing realisation amongst investors that a company has a poor financial foundation (e.g. high debt and low profits), then this can lead to selling.
The urge to sell
When stock prices fall, it is difficult to resist the temptation to sell your shares. This is because humans have a strong “loss aversion” instinct, which urges us to “cut our losses” when things go bad so that we can preserve what we have left.
This instinct served us well in the natural world when it came to food, shelter and clothing. With investments, however, it can lead to irrational decisions. For instance, in March 2020 the stock market fell dramatically as investors reacted to COVID-19. Several pensions lost 25% of their value, or more. Yet by April 2020, the markets were starting to recover as western governments implemented support measures (e.g. furlough) whilst central banks cut interest rates.
Many of the investors who “panic sold” during March were left nursing deep losses, whilst those who held firm to their strategy soon recovered – and surpassed – their previous portfolio value. This shows the danger of panic selling – it crystallises losses which may otherwise have been temporary. Letting your emotions get the better of you is very risky when investing.
Stay true to your strategy
How do you keep your head in a volatile stock market, and is there ever a good time to sell your equity investments? Here, it helps greatly to have a long-term investment strategy agreed with a financial planner, who can act as a “sounding board” for your concerns during a falling market. A professional can help you confront difficult questions to help you discern how much volatility you can cope with, and which investments best suit your risk profile.
For instance: “What would you want to do if your equities suddenly fell 20% tomorrow?” If you are honest with yourself and know that you would want to sell, then perhaps you should steer to a more “defensive” portfolio which comprises more stable investments – like bonds (although these will offer lower potential for returns). However, perhaps you recognise that, despite any short-term volatility, your equity investments are likely to grow overall in the long-run. If you are comfortable with this, have a 10+ year investment horizon and are focused on capital growth (rather than preservation), therefore, then a more “aggressive” or “adventurous” portfolio with a high proportion of equities may be more suitable for you.
The benefit of having a long-term strategy like this, regardless of your asset mix, is that you are more prepared for stock market falls – when they inevitably come. It is important to review your strategy periodically with a financial planner, moreover, to make sure it still reflects your goals, priorities and risk tolerance.
Conclusion & invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
