Dusting off the Bear Market Playbook

In my book Stewardship, written just after the last Great Financial Crisis, I likened the market meltdown of 2008-09 to Capt. Chesley Sullenberger's "Miracle on the Hudson" US Airways flight that year – an emergency landing, not a crash landing. But one that nonetheless left its passengers standing on the airplane wings dazed and confused, if not outright traumatized. 

We haven't reached that point yet in this year's market correction. And hopefully we won't. The conditions underpinning the more than 20% and 15% declines, respectively, in stocks and bonds this year are very different from what they were in 2008-09, when the U.S. stock market declined peak to trough by 56%. But I thought it might be helpful to revisit what I offered back then as a playbook for dealing with extreme market volatility. 

Rule #1 in the playbook:
When in Doubt, Do Nothing. 

If you have worked with an advisor to put together an asset allocation plan that has set long term targets based on your individual risk and return preferences and your time horizon, the worst thing you can do is pull the plug on that plan mid-stream in favor of a more "conservative" approach. The research on market timing is irrefutable: most of the time you will make matters worse, not better. Financial markets "revert to the mean." Professionally constructed plans can generate more predictable returns, given time. 

Rule #2
When in Doubt, Do Something. 

There are several investment-related tactics you can execute to create long term value during a market decline. The first is to harvest any tax losses that might have resulted from a decline in the value of your individual securities holdings. These can be banked to shelter gains in future years. It is important to do this in a way that doesn't change your exposure to the markets in the short term – and it's important to get professional advice before you do so. 

The second tactic is to rebalance to the long-term targets in your asset allocation plan. It's rare that asset classes move in a synchronized way. Stocks behave differently than bonds (although this year, both have declined in value), as do large-cap stocks vs. small-cap stocks, growth stocks vs. value stocks. Rebalancing simply means selling the securities that have appreciated (or declined less) and using proceeds to buy those that have declined. 

Rule #3
Get Expert, Trusted, Dispassionate, Professional Guidance to Help You Tell The Difference Between #1 and #2.

During periods of significant volatility, emotionality can have a big impact on us. It can cause us to act precipitously or freeze us, keeping us from managing risk or taking advantage of investment opportunities. Talking with your financial advisor can provide much-needed perspective in a turbulent time. Connecting with others, putting words to emotions, seeking out seasoned professional guidance – these can all provide a measure of emotional relief, help us get our bearings and stand on solid ground... which is a necessary precondition to effective action and a good place to be when the earth seems to be shifting under everyone's feet.