When markets fall, here’s what to avoid doing

We briefly run through some pointers of what to do and what to avoid doing when stock markets fall.

In times when stock market fall sharply, as they did last week for a period, it is important to keep a cool head and take the long view rather than making rash decisions. 

The FTSE 100 index was down just under 2% last week, amid concerns over the strength of the post-pandemic global economic recovery. US markets, including the S&P 500 index, also ended the week in the red.

Fund managers are increasingly adopting a ‘glass half-empty’ attitude. A standout finding from the latest Bank of America Merrill Lynch Global Fund Manager Survey was that just 27% of respondents said they expected the global economy to improve from here. It is the lowest percentage since April 2020, when the Covid-19 pandemic was starting. 

Separate research from Bank of America points out that over the past 90 years every economic recovery has had a substantial market sell-off in the first two years. So far, this has not played out with the Covid-19 market recovery.

• History suggests markets are heading for a correction
• The inflation-proof shares fund managers are backing
• Fund managers are turning bearish on the global economy 

Below, we briefly run through some pointers on what to do and what to avoid doing when stock markets fall sharply in a short space of time.

Don’t panic, and instead think long term

As history shows, for those willing to take a long-term perspective such sharp dips end up being a mere footnote in the grand scheme of things. Indeed, at times of stock market turbulence, it is worth remembering that volatility is part of the deal in investing in equities. It is the price investors pay for the fact that, over the long run, putting money into shares rather than leaving it in cash will yield greater rewards.

For those concerned that they may panic-sell when markets fall on bad news, it is well worth considering drip-feeding money into the market. A regular plan, involving investing at the start of every month, for example, does away with the risk that you might put all your cash into the market just before a nasty dip.

This strategy benefits from what is known as pound-cost averaging. When stock markets fall, the regular investment purchases more shares or fund units. Conversely, when stock markets rise, fewer shares and fund units are bought. 

Diversify, diversify, diversify

While it doesn’t sound very exciting, maintaining a balanced and well-diversified portfolio is the best way to ride out short-term market falls.

Diversification involves having a mix of investment types, primarily shares, bonds and commercial property. Diversification can also be achieved through mixing large and small companies, having a spread of sectors and regions, and through different investment styles – such as through having exposure to both growth and value funds. Allocating to alternatives, such as infrastructure, private equity and commodities, can also improve diversification.

The theory is that different types of investments are unlikely to all outperform or underperform at the same time, which reduces the volatility of your overall portfolio. A mixed investment approach gives a portfolio ample opportunity to grow, while guarding against serious short-term losses.

• How to mix and match interactive investor's Super 60 funds 
• Investing in the stock market: a beginner's guide
• Big shares versus small shares: the pros and cons 

Have some cash ready to invest

Stock market volatility also brings opportunities. It is worth considering keeping a small part of your portfolio in cash, or be ready to add some through new ISA or SIPP contributions. Having cash ready to invest means you are positioned to act quickly, as and when the next market sell-off occurs.