Portfolio Dilemma: what to do after a 20% drop?

Theresa asks: I am fully invested in shares because I don’t want to miss out on further rises in markets. But I’m conscious of the fact that we could see them fall significantly at some point, and want to be ready for that eventuality. 

If I see my portfolio suddenly fall by a large amount (20% or more), what do I do? 

Markets often recover from their setbacks, and big paper losses for your portfolio can often turn out to be temporary. 

But we are only human, meaning our instincts sometimes kick in on the back of big market moves. 

The risk-taker might pile in on a falling stock, or market. 

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Others might freeze and wait and see. Meanwhile, we might see more skittish investors panic and sell down their holdings. 

The key message is not to panic, and instead to consider the situation.

And the shape of any sell-off, or portfolio fall, will influence what you do. 

Is the world ending? 

We don’t know exactly how Theresa is invested. But let’s first tackle a scenario where equity markets broadly seem to be in freefall.  

There can be many triggers for such an event: markets briefly plummeted in 2020 when Covid-19 lockdowns began to become our reality, whereas today all manner of factors from interest rate rises to an upset from artificial intelligence (AI) shares could worry investors.  

We are already experiencing one nasty sell-off at the time of writing, in the bond market. 

If the leading markets were to sell off, that could be painful for many investors. 

Our data shows that ii customers consistently back broad global equity trackers, leaving them heavily exposed to the US market. 

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A sell-off for the world’s biggest market, or even just for its biggest seven constituents, could be painful for such funds. 

And if the sell-off had a valid reason (such as a global recession), it could prove long-lived. 

Investors should therefore ask how serious the situation is, although generally it does make sense to stay invested. 

It’s also important, ideally before any sell-off kicks in, to make sure your portfolio is genuinely diversified. 

That’s important enough when it comes to “global” tracker funds, given their reliance on the US. 

Investors might want to build decent exposure to other regions, while also making use of more defensive asset classes. 

But it has to be confessed that the second task is not an easy one. 

Investors might otherwise want to stay the course in other, unglamorous ways. 

Regular investing will help you take advantage of market falls, for one. 

However, a market crash might prompt some repositioning. If you’re too US-heavy, as discussed, it might be tempting to use new money to buy into different markets and build a good spread of exposures. 

Problem holdings 

If you hold individual stocks or more concentrated active funds, any big falls might prompt an assessment of the holding’s merits. 

Those who held Novo Nordisk AS ADR (NYSE:NVO) a few years back would, in hindsight, have had good reason to question their conviction in the company and its medium-term prospects.  

Funds can also have pronounced moves: so far this year the Ground Rents Income Fund Ord (LSE:GRIO) is down by around 30%, having suffered at the hands of mooted legislative changes. 

Bill Ackman vehicle Pershing Square Holdings Ord (LSE:PSH) is off by 23%, as is software specialist HgCapital Trust Ord (LSE:HGT). 

Big falls here will prompt a bit of soul-searching. 

It’s worth researching the reason behind the move, and unfortunately it is, ultimately, your job to make a call on the outlook. 

Some cases might be straightforward. The Ground Rents Income trust, for one, has seen its investment case severely undermined on the face of it. But others are more convoluted. 

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HgCapital might be a good example here, as would individual stocks caught up in the software sell-off, such as Experian (LSE:EXPN), RELX (LSE:REL) and London Stock Exchange Group (LSE:LSEG).  

Here, investors need to make a call on whether such a fall is justified, how much AI disruption does face such companies, and what the outlook might be. 

Your instincts will once again have a big impact. 

Some investors might prefer to simply sell out at the sight of a threat and avoid any further pain, while others might at least stick with some of their position. 

As mentioned it could lure in the risk-takers, too. 

Again, diversification can be your friend here. 

Taking a hit on HgCapital might be OK if you hold a host of other stocks and funds, spanning geographies and sectors. 

And diversification might limit your overall portfolio losses and prevent any rash decisions. 

If you have a question you’d like to be considered in our Portfolio Dilemma series, we’d love to hear from you. Please contact: editorial@ii.co.uk