The Right and Wrong Ways to Respond to a Market Plunge

The good times on Wall Street couldn't continue unabated forever. In this "What's Up, Bro" segment from the Motley Fool Answers podcast, hosts Alison Southwick and Robert Brokamp consider the dreary February slump in the U.S. stock market and offer up some constructive moves you can -- and, more importantly, shouldn't -- make to profit amid the volatility.

A full transcript follows the video.

This video was recorded on Feb. 13, 2018.

Alison Southwick: All right, Bro, what's up? I have been pretty much in a coma for the last week, and so did I miss anything?

Robert Brokamp: Not too much. The market has just continued to keep going up, as it has, for the last eight years.

Southwick: Oh, that sounds great!

Brokamp: Oh, kidding about that, actually.

Southwick: Oh, nuts. What happened?

Brokamp: Yeah, what happened? I wrote on February 2nd an article for my Rule Your Retirement service about how great January was. It was the best January for the S&P 500 since 1997. The best January for the Dow since 1987. Things were looking really good for this year.

I also pointed out that there were two rough days at the end of January, and it broke a streak of days where the market did not have back-to-back losses of more than 0.5%. That streak had been going on for over 300 trading days -- twice as long as the previous streak. It just went for a long time where you didn't have back-to-back losses. But I also pointed out on February 2nd that one streak that was still going on was that we did not have a day where the market dropped 3% from the previous close and that streak was an all-time record, as well.

That was on February 2nd. What happened on February 5th? The market dropped 4%. Since then the market has sort of gone down continually -- up and down, here and there -- but now to where we are in correction territory, meaning that the market is down off 10% from its high. I think it's shocking for people because for the most part it has been an incredibly non-volatile market. A very smooth ride in this bull market, and so the last week or so has been a little shocking for people.

Southwick: I appreciate that you said the market is off 10%. Well, you said it was 4% and then when we're in correction territory it's off 10%, because the headlines were Dow suffers largest point drop in the history of human suffering. But the Dow was so high...

Brokamp: Right...

Southwick: ... that yes, you're going to see a large point drop, but in the grand scheme of things, the percentage drop was not as bad as the headlines maybe made it sound.

Brokamp: So, a thousand-point drop does sound very bad, but when you have the Dow doubling in a little bit more than five years, it's not quite so bad. From a percentage standpoint, it was something like the 103rd or 104th worst day since 1900. That's still pretty rough, but that's not as bad as the worst day ever.

Southwick: How should our listeners feel?

Brokamp: First of all, they should feel like this is normal. This is what the market usually is like. According to American Funds, from 1900 to 2016 a stock market decline of 5% has, on average, occurred three times a year. You can expect a 10% drop about once a year and a 20% or more drop every three and a half years, but we haven't seen it in a decade. This is just what happens in the stock market, so people should accept that this is what happens.

Now, as always, it's never too late to rebalance. If you're in a situation where you need the money in the next few years, if you're getting close to retirement, or you're in retirement, it's not a bad idea to take some money out of the stock market. Don't worry that it's down 10%. It's still not too late to rebalance, especially since even despite this 10% drop, by most measures the market is still overvalued.

The good news about what has happened over the last several weeks is one of the many reasons people think the market has gone down is because interest rates have gone up. That can be bad for companies, but it can be good for other types of investments. For example, the one-year Treasury, the most boring investment in the world, now yields almost 2%, providing a yield it hasn't yielded since January of 2008. So, in other words, the safest investment in the world is now offering the best returns it's had in a decade.

So, for money you need in the near term to protect, the one-year Treasury is a great solution. You can usually get them commission-free from your broker or directly from Uncle Sam at Treasury.gov. I think that's the way to play it. Protect what you need in the near term, but just accept that 10% declines are part of normal business for being a stock investor.

Southwick: What's the worst thing that someone should do amid this volatility?

Brokamp: Thinking that they can move money to the sidelines and wait until things calm down. You hear variations like that all the time. "I'm going to move money to the sidelines until things calm down a little bit."

Southwick: Which means cashing out your stocks and getting a larger horde of cash.

Brokamp: Right. You basically have to know when things have calmed down in the stock market, and good luck with that. Nobody really knows.

Southwick: Yes, a lot of the headlines were like this drop was spurred by inflation fears, or the drop was spurred by some sort of ETN [which I don't want you to bother explaining right now] going haywire. To what extent does it even matter? As an individual investor, you can't really impact that or have an effect. Should you just be like, "Ick! It did it because it did it?"

Brokamp: Right. First of all, no one really knows why the market goes down. And even if you could figure it out, whatever that event was you're not going to be able to predict it before everyone else can and cash in on it.

Southwick: You're not that smart.

Brokamp: Exactly. There's a lot of talk, too, about how much of this is due to computers and all the high-frequency trading. Anywhere from 50-70% of trading on any given day is actually done by computers. Are you going to outguess what all those computers are going to do? Probably not.

Hold onto good companies. Hold onto good dividend payers if you're retired. Know that whatever the situation is going on today, 10 to 20 years from now you're going to be happy that you held on.

Southwick: So, basically your advice is take money out and don't take money out of the market.

Brokamp: Take money out that you need for the next three to five years [or seven years if you're a little more conservative], but any money that you do not need for any time period getting close to a decade or longer you're going to be happy that you held on.