U.S. Markets closed
  • S&P 500

    -5.76 (-0.16%)
  • Dow 30

    -173.77 (-0.58%)
  • Nasdaq

    +57.62 (+0.48%)
  • Russell 2000

    -8.51 (-0.46%)
  • Crude Oil

    -0.46 (-1.01%)
  • Gold

    +5.50 (+0.30%)
  • Silver

    -0.01 (-0.03%)

    -0.0013 (-0.1072%)
  • 10-Yr Bond

    -0.0040 (-0.45%)
  • Vix

    -0.39 (-1.80%)

    -0.0047 (-0.3507%)

    -0.1900 (-0.1819%)

    -692.37 (-3.85%)
  • CMC Crypto 200

    -32.13 (-8.67%)
  • FTSE 100

    -28.32 (-0.44%)
  • Nikkei 225

    +240.45 (+0.91%)

Here's how smart investors will react to this week's market drama

Mandi Woodruff

This post has been updated from an earlier version published Monday, Aug. 24.

It's been a bumpy ride for investors this week. As if last Friday’s 500-point plunge in the Dow Jones Industrial Average weren’t distressing enough, we woke up Monday to yet another market drubbing as global indexes, led by China, plunged, and a wrenching 1,000-point drop at the open Tuesday.

However, the U.S. market looked poised for something of a comeback by Wednesday morning. By late morning, the Dow (^DJI) was up around nearly 200 points, or 1.2%, the S&P 500 (^GSPC) was 24 points -- or 1% -- higher, and the Nasdaq (^IXIC) was up around 60 points, or about 1.3%. Indexes looked like they were in recovery mode, but investor anxiety no doubt remains.

As we all should know by now, however, it's a bad idea to follow your gut instincts when it comes to market-fueled panic. Now isn’t the time to sell investments and start padding your mattress with dollar bills, experts say. For the average 401(k) investor, the answer to what you should do in reaction to today’s downturn is simple — just hang in there.

Investors have a tendency to feel that they can take more risk when the market is going up and tend to add to their stock investments, versus when the market is going down, which leads people to panic and sell. But when you do this, you're committing one of the ultimate sins of investing — buying high and selling low, says Avani Ramnani, certified financial planner and director for financial planning at Francis Financial.  

Dips like this aren’t uncommon. Although the S&P is at a six-month low —  down about 9% over that span— in order to enter a bear market, the S&P would have to fall 20% or more over a period of at least two months. We’re also nowhere near the depths of the 2008 financial crisis when the S&P 500 plummeted 45% from its 2007 high. According to a JP Morgan Asset Management report, even with average intra-year declines of 14.2% for the S&P 500 over the last 35 years, annual returns were still positive 27 out of 35 years. This is a reality investors have to be prepared for, says Peter Mallouk, president and chief investment officer of wealth advisory firm Creative Planning. They’ve got to ask themselves this: Am I going to freak out every time this happens? Or am I gonna step back and say you know what this is gonna happen 40 or 50 more times in my life and I need to have a decision making process in place.”

Ric Edelman, CEO and chairman of Edelman Financial Services, also notes that while yields on U.S. treasuries and bonds have been declining, that also means prices are going up. “That’s doing a good job of counterbalancing the losses of the stock market, which is the whole point of being diversified in the first place,” Edelman says.  

If you start fiddling with your investments or trying to guess which sector is poised to bounce back the fastest, there’s a good chance you will guess wrong. If you have worked with a financial advisor to come up with a long-term investment strategy that works for your age, time horizon and risk tolerance, then simply stay the course. For those closer to retirement, the chances that your portfolio is heavily weighted in stocks are slim, especially if you’re invested in something like a target date fund, which automatically shifts portfolios out of stocks and into cash and bonds as you age.  “If you’re within five years of retirement you should have enough conservative investments in your portfolio that you don’t care what happens in your portfolio,” Mallouk says.

However, if you’re getting shaken up by today’s drama or you feel like your portfolio took a nastier dip than you feel comfortable with, then maybe it’s time to sit down with a financial planner who can help you rebalance, if necessary. Most experts recommend a portfolio refresh once every year or so anyway.  

Now that we’ve got the facts out of the way, here’s the good news: think of today’s downturn as one big flash sale. So maybe you didn’t have the foresight (and, honestly, who does?) to sell appreciated stocks last week, but that doesn’t mean you can’t take advantage of cheaper assets now. “This is an opportunity to get cash into the market if you’ve had money sitting on the sidelines waiting for a good buying opportunity,” Edelman says. “We’d encourage people with a three- to five-year time horizon to do exactly that.”  As far as what to buy, Edelman recommends sticking to broadly diversified exchange traded funds or low cost mutual funds in U.S. and foreign markets, with a mix of both large- and small-cap stocks. What he doesn’t recommend is trying to guess which sector is going to perform the best next and try to buy in. “That’s a sucker’s bet and it’s highly likely that you won’t get it right,” he says.  

How did you react to today’s market news? Got a question about your 401(k), retirement or anything else finance-related? Drop us a note at yfmoneymailbag@yahoo.com or check out Ask Yahoo Finance on Tumblr.

Read more:

5 ways to stay calm as markets plunge