Sharp market declines can be unsettling, especially when you watch the value of your investments fall quickly. But not every downturn is the same. A correction generally describes a decline of more than 10% but less than 20%, while a bear market typically involves a drop exceeding 20%. A market crash is less precisely defined and generally refers to a sudden, severe decline.
Understanding what's happening can help you evaluate your portfolio without allowing short-term headlines to dictate every decision.
Avoid Making Decisions Based Only on Panic
Selling during a sharp decline turns an unrealized loss into a realized one. It also creates another difficult decision: determining when to reinvest.
Markets can recover before the economic outlook feels reassuring, making it difficult to identify the bottom in real time.
That doesn't mean selling is always inappropriate. Your financial circumstances, investment goals, or need for cash may have changed. The key is distinguishing a planned portfolio adjustment from a decision driven primarily by fear.
Review What You Actually Own
A downturn can be a useful time to understand what's inside your portfolio.
Determine whether you're holding individual stocks, ETFs, mutual funds, bonds, cryptocurrency, or other assets.
Then consider why each investment is there. Knowing what you own makes it easier to determine whether your original strategy still makes sense.
Check Your Diversification
Owning several investments doesn't automatically mean you're diversified.
Multiple stocks from the same industry, for example, can react similarly to an industry-wide problem. Diversification can involve spreading exposure across different companies, sectors, and asset classes.
Diversification can't prevent losses during a broad market decline, but it can reduce your dependence on the performance of a single company or sector.
Revisit Your Risk Tolerance
Your portfolio should ideally reflect your ability and willingness to tolerate losses before a downturn occurs.
If normal market volatility is causing considerably more stress than expected, reviewing your asset allocation may be worthwhile. However, changing your entire strategy because of a few difficult weeks is different from recognizing that your original risk assumptions were unrealistic.
Your investment timeline matters too. Money needed soon generally has different risk considerations from money intended for goals decades away.
Consider Consistent Investing Instead of Finding the Bottom
Trying to identify the exact bottom of a market decline is difficult.
Dollar-cost averaging takes a different approach. You invest a predetermined amount at regular intervals regardless of what the market is doing.
When prices are lower, the same contribution purchases more shares; when they're higher, it purchases fewer.
This doesn't guarantee a profit or prevent losses, but it reduces the need to make every investment decision based on short-term market predictions.
Be Especially Careful With Margin
Borrowed money can make downturns more dangerous.
Margin allows you to invest using funds borrowed from a brokerage, with investments generally serving as collateral. Both potential gains and losses are magnified.
If falling prices reduce account equity below required levels, you may face a margin call. If you can't meet it, the brokerage may be permitted to sell securities from the account.
That can force investments to be sold during an already unfavorable market.
Determine Whether Rebalancing Is Necessary
Market movements can push your portfolio away from its intended allocation.
If your target was a particular mix of stocks and bonds, strong or weak performance in one category can gradually change that balance. Rebalancing restores the portfolio toward its intended allocation.
Rebalancing isn't necessarily a prediction about what the market will do next. Its purpose is to keep the portfolio aligned with your established risk strategy.
Understand the Tax Opportunities and Risks
Market declines can create tax considerations, but tax strategies require care.
In taxable accounts, realized investment losses may potentially offset capital gains. This practice is commonly called tax-loss harvesting. Rules governing substantially identical replacement investments can affect whether the loss receives the intended tax treatment.
Lower account values can also affect the tax calculations associated with certain retirement-account conversions. These decisions may influence taxable income beyond the investment account itself, making professional tax guidance useful.
Maintain Emergency Savings
Cash reserves can indirectly protect your investment strategy.
If an unexpected expense or income disruption occurs during a market downturn, emergency savings may reduce the likelihood that you'll need to sell investments simply to raise cash.
The appropriate amount depends on your expenses, income stability, household needs, and other financial resources.
Focus on What You Can Control
You can't determine when the next correction, bear market, or crash will happen. You also can't know exactly when prices will recover.
What you can control is more practical: how diversified your portfolio is, whether you're using borrowed money, how much emergency cash you maintain, and whether your investments still align with your goals and risk tolerance.
A market decline doesn't automatically require action. Sometimes the most important step is simply reviewing your financial plan and making sure the reasons behind your investments haven't changed.
