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Say the market falls 40% - What should we do?

#11
This is what happened in 2008.

The right action was to sit tight and increase investment at that nadir.
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#12
Not sure about sitting tight - even in 2008 although I know some who did are satisfied. However, there are often some real losers when it hits the fan and my take is that it is to your advantage to get rid of the losers if you are pretty sure you are holding some.

For what it's worth, I lost a bunch of stocks to stop orders and picking up CDs (good Treasuries were gone) with some of the funds from stop orders turned out to be a good deal.
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#13
Such a great question, DreamFire! These answers are a reinforcement to experienced investors, as well as good advice to beginners.
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#14
Great question! It will be scary, but... guess what? We have all seen this movie play out before!!!
It is noteworthy how critical is to keep a good amount of dry powder for whenever these opportunities happen. I guess in your case you can consider your fixed income as cash unless you have any pure cash reserves.

I would use the cash to buy into the stocks of solid companies that have dropped w/o factual data; companies that we all need from on a daily basis like $PG $JNJ $BMY etc. I would spend the cash in predetermined incremental steps as opposed to spending it all at once. I like to start moving cash into stocks or index ETFs when the underlining stock has dropped 3-5% from the peak and keep adding at further 2-3% price drop if the price continues to head south w/o a good reason. I plan ahead for a 10% drop using say 4 buying steps, so divide my cash per allocation in 4 and that is what I buy at any particular point. You also have to be methodical on you selling strategy otherwise you never have cash available to seize these type of opportunities. In such a large market drop I would choose a few staples and then start buying the indexes and still buy in 4 steps. You don't want to get greedy because greed brings emotions into the game and we start selling low and buying high.
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#15
Some great replies here!

I suppose it depends a bit - as some have said - on where you are in life and on what prior experiences you have had.  It is also hard to really know what one would do in a hypothetical case like this. Our actions in the real world may be different, depending on circumstances.  However, it probably is good to think about what to do in a market correction before it happens and have some kind of plan, even if this particular case is somewhat exaggerated (I hope).

What I think I would do:

1. Re-balance by buying more equities.  I would probably re-balance to return to $500k in equities at the expense of fixed income, which equates to a 62.5/37.5 split between equities and fixed income (rather than 50/50).  My thinking is that in general, the lower the equity market, the happier I am to own equities.  If the market eventually rebounds (which is the past experience), I will also make more money "buying low and selling high".  There is a maximum equity/fixed income split that I would not exceed (if the market continued to fall and I continued to re-balance), but it is higher than 62.5/37.5.  Maybe 80/20 or 70/30, but it likely depends where you are in life, how large your portfolio is, and how much you need to take in income from that portfolio, if any.

2. Take tax losses.  I would look at my taxable accounts and identify any funds that now have capital losses.  If I identify any with losses, I will look at exchanging them for funds that are somewhat similar but are different enough to avoid running afoul of the IRS wash sale rules.  I will try to use these capital losses to reduce my ordinary income at the IRS maximum rate of $3k per year, carrying any unused losses into subsequent years.   I assume I will eventually have to take capital gains on the new funds, but plan to hold them long enough for them to be long term capital gains.

3. Reassess where I am in terms of meeting financial objectives, given the losses. Do I need to change anything? Expenses/Withdrawals/Contributions?

4. Further reassess my asset allocation among various asset classes as it is likely that not all assets have fallen equally.  And it is possible certain classes may be expected to do a little better going forward.
 
Anyway, that's my plan.  I appreciate everyone's input so far as well as any further comments.
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#16
Ybserp, Your thoughts are rational and well reasoned.  Yet in the face of a sharp 30% drop in equities with no ability to know if a bottom has set in one needs nerves of steel to sell likely raising bonds to buy additional stock via a re-balance.  I wish you the best on your well thought out plan, but do you believe you have the will to enact it?  Most panic and sell equities, a some sit tight,  a small fraction seek to catch the falling knife.
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#17
Hello Jeepo. At the end of your post, you indicated three groups of investors. Would you agree, that a strategy of a small fraction, seeking to catch the falling knife, will be most successful? They are using sharp decline (30-40%) to buy more equities. In reality, no one knows if a bottom has set. Since stock market always recovers (regardless of how long it takes), this small fraction, eventually, will make most of this buying opportunity.  As far as prior post from Ybserp, I would also attempt to re-balance by buying more equities, but, at first, by bringing new money, if possible, before selling my fixed income. Honestly, not much to sell anyway. According to Fidelity portfolio analysis, I only have 5% in bonds....But, of course, everyone's situation is different.
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#18
Ybserp - I was betting that you would have temporarily added to your fixed income.  For those of us holding those boring taxable bond funds in 2008, the impending 'flight to safety' provided a nice low beta recovery.
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#19
Would the falling knife segment be most successful?  Yes on the premise the market recovers relatively quickly.  One could also envision a market drops further after ones purchases or just drifts along at a low level for sometime.  In the latter case staying in bonds for awhile and re-balancing at a much later date would be preferred.
 
The market always recovers to its former price level due to the affects of inflation and profit making capabilities of businesses.  Yet the market took sometime to recover after the 1929 crash.  If the Fed had not poured money into the system the 2008 drop could still be ongoing.
 
If buying on the big dip was an assured method for large future returns all market drops would be very short lived.  And in the limit would thus never occur.  Yet experience does not bear this out.
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#20
(11-28-2018, 10:53 PM)MayDay Wrote: Would the falling knife segment be most successful?  Yes on the premise the market recovers relatively quickly.  One could also envision a market drops further after ones purchases or just drifts along at a low level for sometime.  In the latter case staying in bonds for awhile and re-balancing at a much later date would be preferred.
 
The market always recovers to its former price level due to the affects of inflation and profit making capabilities of businesses.  Yet the market took sometime to recover after the 1929 crash.  If the Fed had not poured money into the system the 2008 drop could still be ongoing.
 
If buying on the big dip was an assured method for large future returns all market drops would be very short lived.  And in the limit would thus never occur.  Yet experience does not bear this out.

I have described essentially what I did in 2008-2009.  I would not say it takes nerves of steel, but rather a certain (cold-blooded? unemotional?) detachment.
 
If the market falls further after I have re-balanced - if it falls enough - I will buy still more. (You need to take care not to re-balance too often.) In 2008-2009 I actually bought several times on the way down, at ever lower levels, including a substantial buy on March 9, 2009, which was the bottom (for the S&P 500).  I also sold several times on the way back up, but only after significant upward moves.  I guess you could say that the buying and selling on the way down and the way back up more or less cancelled, except for the buy on March 9, 2009.

(11-28-2018, 02:25 AM)Abe Wrote: Ybserp - I was betting that you would have temporarily added to your fixed income.  For those of us holding those boring taxable bond funds in 2008, the impending 'flight to safety' provided a nice low beta recovery.

What you suggest might be something to consider, depending on the circumstances.  I do wonder how differently things would play out in a decline not precipitated by the financial institutions.
 
I have used the term "fixed income" rather loosely, in my mind meaning bonds/money market/cash, etc.  In 2008-2009, I did own some bond funds,  but most of my fixed-income type assets were in a "stable value" fund that maintained a $1 share price while paying dividends of over 5% in 2008 and over 3.75% in 2009.  I used this essentially as a money market fund to buy more equities when I increased my equity holdings.
 
The following compares how a corporate bond fund and a long treasury bond fund have compared with a S&P 500 ETF since the market bottom for the S&P 500 of March 9, 2009, including dividends: https://stockcharts.com/freecharts/perf....5&O=011000
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