So how do you react and what is the proper response when there is a stock market drop and the Dow dips more than 700 points in one day, then follows that up with an over 400 point drop the next day? Eleven hundred points sounds like such a big number. There must be some appropriate way to respond to such a big Wall Street shift. The answer to this short-term question can be found in your long-term financial planning.
Big Number, Relatively Small Decline
The most important thing is to view the market drop in context. Remember that the Dow, a somewhat narrow equity index that’s not representative of a well-diversified portfolio, is still over 23,000. So while 700 points and 400 points sound like big numbers, a more informative statistic is to look at the percentage drop (down 2.93% on Thursday and 1.77% Friday) ) rather than the total point drop mentioned above.
For some perspective remember that less than 10 years ago, when the Dow sat at 8,000 points, it would have taken a drop of just 400 points to bring the Dow down approximately 5%, making point drops then much more palpable than the market action on March 22 and 23.
Unfortunately, the financial news media focuses too much on point drops because they engender feelings. Those feelings cause us to keep tuning in, which helps ratings and allows them to charge more to the companies that advertise on their networks.
Refocus on the Financial Plan
The proper response to a bad day in the stock market is to use the experience as an opportunity to refocus on priorities and confirm that they are reflected in your long-term financial plan. When we get market drops like this, it should prompt us to revisit our financial plan to make sure we have the basics covered and that the money we have invested in the markets is allocated to the correct goals, our long-term goals.
So what should that financial plan look like?
Insurance is the Foundation
A financial plan, like anything else that is built with the expectation that it will last, must start with a solid foundation, and in this case, that means having proper insurance coverage.
I know people hate the idea of insurance, but you can have a million dollars saved and have it all wiped away in an instant by one accident in which you are found liable. Most people need health, life, disability, property and liability insurance (also called an umbrella policy) to be considered fully covered.
If you have young children, it is also imperative that you meet with an attorney and have a will drafted with guardianship provisions. Many people don’t realize that if they die without a will, the court decides who will raise your kids, and if there is any disagreement among family as to who that should be, the kids stay in foster care until the court figures it out.
If for some reason you can’t make it to an attorney and need an immediate solution, check out legalzoom.com. I don’t believe this service replaces a competent estate planning attorney that can provide personal service, but it is better than nothing.
Debt Elimination, Savings are the Building Blocks
There is no reason to invest your money with the hope of earning 6% – 8% if you are borrowing money from credit card providers at over 20%. This scenario is a loser every time. There’s no winning, ever, just losing. Get yet? Pay them off.
Along these lines, if you are sitting with $15,000 in your checking account, but you have $8,000 in credit card debt, please use the funds in your checking account to pay off your debt. You are likely earning .01% on your checking account money and again borrowing at over 20% through your credit card debt.
While the money in the bank makes you feel “safe” and “comfortable,” it is not helping your financial situation; instead, it is just making it more difficult for you to achieve your financial goals.
Eliminating credit card debt will allow you to save money for your emergency fund. This fund will make sure that you no longer have to worry about accumulating into credit card debt again. For example, when the air conditioner goes down or you need an expensive repair on your vehicle, you can simply pay for it with cash.
Retirement and Other Long-Term Goals
Once the foundation is set and the building blocks are taken care of, you then get to focus on your exciting, long-term goals like retirement, paying for your children’s college and maybe even luxury purchases like a boat or vacation home. The important point here is that these are long-term goals and you need to invest in them accordingly.
Any cash needs in the next five years for these goals or for part of a withdrawal plan for retirement should not be invested in equities; they should be in asset classes with little or no volatility. This will allow you to avoid making emotional decisions based on short-term market volatility, like over 700 point dro…. oops, almost 3% drops in the Dow.
If you haven’t recently reviewed your financial plan you should contact your CERTIFIED FINANCIAL PLANNER™ Practitioner.
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