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What to Do about a Bad Day (or Week) in the Stock Market

On Thursday the U.S. stock market (as measured by Vanguard’s Total Stock Market ETF) went down by 2.17%. And on Friday it went down by 2.88%. The week’s market performance (down approximately 5.5% in total) has received quite a bit of news coverage, and if my email inbox and Facebook feed are any indication, many people are nervous — or even downright scared.

This Could Be No Big Deal

According to Yahoo Finance, in the last 5 years (i.e., during a roaring bull market) there have been 8 other days worse than Friday and 28 days worse than Thursday.

You might say, but this was two bad days in a row, surely this is a problem! Well, those 8 days worse than Friday? Two of them were in a row as well (9/21/11 and 9/22/11). In fact, all 8 of the days that were worse than Friday occurred within the August-November window of 2011. Perhaps, like me, you have already forgotten about that brief little period of not-so-great returns. Until looking at the data just now, I had forgotten about that period because it turned out to be no big deal. The market continued to climb for another (so far) nearly 4 years after that.

In other words, this sort of thing is normal, and it can even happen right in the middle of a period of great market returns. It doesn’t necessarily mean the bull market is over.

But Maybe We Are in for a Crash

On the other hand, maybe this is the beginning of the next bear market. We could be in for a much greater decline. In the 2007-2009 decline, for instance, the market fell by more than 50%.

If last week’s not-that-big-of-a-deal performance has you in near panic mode already, you have learned an important lesson. Specifically, you have learned that you overestimated your risk tolerance and chose a portfolio that is probably too risky for you. If a decline of less than 10% has you scared, imagine how you’d feel if the market fell another 40%.

The point of strategic asset allocation is to give up on guessing where the market is going next and instead craft a portfolio that will allow you to sleep well at night, regardless of whether we’re in for another 4 years of great returns (as we were after that little blip in late 2011) or a further decline of 40% or more.

What to Do Now?

Evaluate. How are you feeling about your portfolio and its risk level right now?

If you’re feeling perfectly comfortable, this week could be a great time to rebalance your portfolio back to its target allocation, which likely means buying more stocks. (It may also be an opportunity to tax-loss harvest.)

On the other hand, if you’ve been stressing about this modest decline, you may want to scale back your stock allocation somewhat. Yes, that means selling immediately after a decline, which isn’t ideal. But chalk it up as a lesson — one that could have been much more expensive.

And take note of the stress you’ve been feeling. Literally. Make a note of it. Record how you are feeling right now. Then sign and date that document. You want something that you can refer back to the next time things are looking rosy and you are tempted to bump up the risk level of your portfolio (to a level that you have already proven is too risky for you).

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