100-point market declines aren’t what they once were
If you’re an active investor, you probably follow the movement of the financial markets at least somewhat regularly. If so, you have no doubt noticed what appears to be considerable fluctuation—in the form of triple-digit movements of the Dow Jones Industrial Average, one of the most widely watched market indices. Should you be concerned about these movements, especially when their direction is downward?
At first glance, a 100-point drop might look rather ominous. But is it?
It might have been—about three decades ago. When the Dow stood at about 1,100, a 100-point fall would have meant a 9 percent drop in one day, which would probably have qualified as a significant event. But today, with the Dow hovering above 20,000, a 100-point fall only translates to a 0.5 percent decline. Not such a big deal.
Actually, it’s not that unusual for the stock market to drop by 10 percent about once a year, though this decline usually takes place over a period of several weeks rather than in a single day. To put this figure into the context of the Dow at 20,000, a 10 percent decline would be a drop of 2,000 points.
So, we have seen a few 100-point drops in the past while not reaching a level of a fairly normal decline. But even if we do get there, should you be greatly concerned?
As mentioned above, market declines are both normal and frequent. However, many people, especially those who are fairly new to investing, misinterpret these declines as a sign that there is something “wrong” with their investments. Consequently, they may sell some of these investments or even take a “time out” from investing, both of which can be mistakes. Selling investments when their price is down violates the first rule of investing—“Buy low and sell high.” And, as far as taking a “time out” from investing, you could find yourself on the “sidelines” when the next market rally begins, thereby missing out on opportunities for potential gains.
The more you know about the workings of the financial markets, the less likely you’ll be to overreact to declines. For example, what causes market volatility? At any given time, a number of factors could be responsible: political turmoil abroad, disputes over policy in Washington, concern about potential Federal Reserve actions, and so on.
It’s important to understand, however, that these factors are often short-term in nature—and so are their effects on the market. To be a successful long-term investor, you’ll want to examine the fundamentals of any individual investment you’re considering. When looking at a stock, ask these questions:
- Does the company have a good management team in place?
- Are its products competitive?
- Is the stock priced fairly, relative to its earnings?
When evaluating a bond, make sure it’s considered “investment grade” by one of the major bond-rating agencies. And when looking at a mutual fund, examine its stated objectives, its track record in all different economic environments, its level of diversification, and other key factors.
If you’ve chosen quality investments, possibly with the assistance of an experienced financial professional, and these investments are suitable for your risk tolerance and time horizon, you really shouldn’t have to worry about market declines. In fact, although it may sound counterintuitive, you might even welcome these periodic downturns. For one thing, they will give you a chance to see how your investments respond in different market environments. Also, a declining market may well give you the opportunity to purchase quality investments at lower prices. Again, the “buy low” principle is worth considering.
By having confidence in your choice of investments, and by being prepared to take advantage of the possibilities presented in a market downturn, you’ll be well-prepared to cope with those supposedly “dizzying” triple-digit drops in the Dow.