TORONTO — When it comes to understanding — and reacting to — the type of steep stock market movements seen in recent days, context is everything.
That's the key lesson experts say anxious investors should heed in the wake of Monday's unsettling losses, when the Dow Jones industrial average free-fell to close down nearly 1,200 points, or 4.6 per cent, and downward pressure on global equity markets took Canada's largest stock index down about 1.7 per cent.
"The media sometimes fan the flames of an episode like this. Yes, this may have been the worst point decline in the history of the Dow, which was down as much at 1,600 points on Monday, but that's only because it reached an all-time high value this year," said Jason Heath, a financial planner with Objective Financial Partners in Toronto.
In percentage terms, Monday's decline doesn't even make the list of the top 20 worst in history, with the worst being "Black Friday" or October 19, 1987 — when the market dropped 22.61 per cent or 508 points.
The markets rebounded Tuesday after a highly volatile day of trading and what happens next is anyone's guess, so investors should prepare to strap in for a bumpy ride.
"The only thing we know for certain is that stocks will go up or down from here. And over a short period of time, it's tough for anyone to know what's going to happen. Over the medium term, stocks will probably be up. And over the long term, they will definitely be up," said Heath.
Personal finance experts such as Heath say episodes like this reinforce two things: the benefits of diversification and the importance of determining your risk tolerance.
"Diversification helps ensure everything doesn't move in the same direction at the same time," Heath said.
And if Monday's correction of less than five per cent caused you to consider selling stocks, perhaps you should reconsider whether you have too much stock exposure in the first place, Heath added.
"An investor needs to be comfortable knowing that if they have 50 per cent in stocks, they will experience half the declines of a stock market pullback."
While many market observers say a correction was expected after a decade-long bull run, the trigger that sparked the sudden downturn is thought to be U.S. figures released Friday that suggested long-anticipated wage growth has started to kick in, resulting in inflation and a greater potential for the U.S. Federal Reserve to raise interest rates.
An increase in interest rates pushes bond yields higher and makes such fixed-income investments more attractive and thus, bets on corporate earnings and dividends less attractive.
Heath said that for investors with actively-managing portfolios, there is definitely a benefit to being more conservative at this point in the market cycle.
"Ideally as someone is rebalancing their portfolio, as stocks have been rising up until the last couple of days, they should have been taking profits, selling stocks, repositioning into bonds accordingly — if they haven't, this is a reminder about why you should do that," he said.
If interest rates rise, investments like real estate investment trusts and utilities, to which many investors have looked to provide a source of steady income, are expected to come under pressure.
Sectors that took the biggest hit on Monday's free-fall were the financial, consumer discretionary and industrial stocks. "Those all tend to be sectors that do well early in the business cycle and had been really been running up a lot lately, particularly technology," Heath said.
Personal finance commentator Preet Banerjee said that during times of stock market uncertainty, it's critical to make sure your financial plan is up to date. That means having clearly defined investment goals and a portfolio that has been designed to help you reach them. A properly constructed portfolio should take into account your savings goal, risk tolerance and time horizon, which helps you select the right diversified mix of stocks and bonds.
Above all else, Banerjee said that during times of short-term stock market volatility, the best strategy is to focus on fundamentals and rebalancing between asset classes as opposed to trying to predict where the markets are heading.
He pointed to investors who sold their stocks following the sharp market declines after the Brexit panic in June 2016 paid a dear price when markets rebounded days later. A similar scenario occurred following the 2008-09 financial crisis when stocks sold off significantly but later rebounded, albeit more slowly.