What to do when markets fall

Market declines are a normal feature rather than an aberration. What differs between retirees is what they do during them.

The context

Substantial declines occur regularly. Falls of ten per cent happen frequently, twenty per cent falls occur every few years on average, and larger declines have occurred several times within a typical retirement.

Which means a thirty-year retirement will contain several, and any plan that assumes otherwise is not a plan.

The historical pattern is recovery, over periods that have varied from months to several years.

None of that guarantees future recovery, and it does establish that declines are expected events rather than failures of the plan.

What is useful during one

Nothing, usually. The most valuable action is generally inaction, which is also the hardest.

Rebalance. If the allocation has drifted beyond its band, rebalancing means buying equities after they have fallen.

This is uncomfortable and it is the discipline that a written policy exists to enforce.

Harvest losses in taxable accounts. Sell holdings at a loss, replace with a similar but not identical fund, and bank the loss against future gains.

Market exposure is maintained and a genuine tax asset is created.

Convert to Roth. A decline reduces the tax cost of converting a given number of shares, and the recovery occurs inside the Roth account.

Draw from cash rather than equities. Which is what the cash reserve exists for.

Review discretionary spending. Modest reductions during poor years materially improve long-term outcomes, and the earlier they are made the smaller they need to be.

Check the plan against the stress test. If you modelled a thirty per cent decline in advance, compare what has happened to what you planned for.

Frequently the actual event is within what was already anticipated, which is reassuring in a way that watching daily coverage is not.

What to avoid

Selling equities to stop the loss. This converts a temporary decline into a permanent one and creates the problem of when to return.

People who sell during declines generally do not reinvest at the bottom.

Abandoning the allocation. Deciding after a decline that you should have been more conservative, and acting on it, locks in the loss and reduces participation in recovery.

The time to reduce equity exposure is before a decline, based on capacity for loss, not after one based on the experience of it.

Consuming continuous coverage. Financial media during declines is optimised for attention rather than for decision quality.

Acting on a forecast. Confident predictions about what happens next are always available and have no demonstrated accuracy.

Buying what has fallen most, individually. Deep declines in specific holdings frequently reflect specific problems.

The preparation that makes this possible

Behaviour during a decline is largely determined by decisions made before it.

A written policy stating the allocation and the rebalancing rule. A cash reserve covering near-term spending. An allocation set at a level you can actually hold. A defined list of what spending would be reduced and by how much.

Each of these converts a decision made under stress into the execution of a decision made calmly.

The specific danger for new retirees

A decline in the first few years of retirement is the sequence risk scenario, and it is the situation where action is most warranted and most likely to be the wrong action.

The appropriate responses are the ones listed above: draw from cash, reduce discretionary spending, delay large expenditures, and consider whether part-time income is available.

The inappropriate response is to sell equities, which is what the situation most strongly encourages.

The honest caveat

None of this guarantees anything. Markets can fall further and stay down longer than expected, and a retirement beginning at the wrong moment faces a genuinely worse outcome than one beginning at a good one.

What the actions above do is improve the odds and preserve the capacity to recover, which is all any plan can offer.

General information only, not financial advice. Past performance does not predict future results — consult a qualified adviser about your own situation.