Understanding “Brexit” and Market Selloffs

photo-1415829994762-1344c5d2dbe9By now you have certainly heard the news that the people of Great Britain have voted to leave the European Union: 52% to 48%.

Last Friday morning U.S. markets responded to the surprising news of the Brexit by opening sharply lower. By the end of the day, the Dow Jones Industrial Average was off more than 600 points or about 3%.

Almost immediately the headlines and news reports started coming in about what investors should do next. I am sure you are wondering as well.

As I have said before, often the best thing to do is nothing – at least at first.

This is so largely because no one really knows how this will affect the major economies of the world or companies that do business in them. Analysts who pretend to have all the answers are just guessing. Until now, no other country has left the EU. There is no precedent upon which to base a solid opinion.

While the fallout for Great Britain may be dire, no one really knows what it means for the rest of the EU or the world economy in general. In fact, it’s that uncertainty that leads markets to sell off and market volatility to rise. My guess is that the closer you are to the epicenter, the more fallout you will face. Great Britain will feel it the most, followed by the EU, then the US and other major economies.

Most experts feel that the Brexit shouldn’t have a direct impact on the U.S. economy, but in an increasingly connected global economy it’s doubtful to me that we will completely avoid the economic fallout of this event.

We’ve been through this before. In August of last year markets were off over 10% taking us into the first official market correction in over 4 years. By the end of October markets had rebounded to their previous highs. In December going into the new year, markets sold off once again. This time they bottomed out in March and rallied into June. Now we have “Brexit” and what may be the start of another downward cycle. Or not. We’ll know more in the days and weeks ahead.

Diversification and planning work. Most clients own a variety of asset classes including not just stocks, but also bond funds and even money market funds or cash equivalents. While almost no portfolio is completely immune to market fluctuations, investors who are well diversified, have ample cash reserves, and focused on the long-term are in the best position to weather these market storms.

By planning ahead and setting aside enough in cash reserves to meet your cash flow needs and any other short term needs you may have, your portfolio has time to recover. It’s when you are forced to liquidate shares in a down market that the real damage is done. That’s why I often recommend clients have enough income and cash reserves to meet 5 years worth of living expenses – or more if you are even more conservative.

Look for opportunities. If you have a long-term time horizon of 5-10 years or more, market volatility can present opportunities to buy more of your favorite stocks or reinvest into your stock funds at lower prices. Other opportunities can come in the form of rebalancing or repositioning some of your investments. I am not a big fan of timing the market, but if an investor owns an asset that they’ve been on the fence about, now may be a good time to put those dollars to work elsewhere.

At a minimum, market selloffs are a great time to revisit your portfolio and update your financial plan just to be sure everything is in place and allocated in a way that balances your long-term needs for growth with your short-term capacity for market losses.

Keep calm and carry on. Now is not the time to panic. One bad day (or week or quarter) in the market is nothing to lose sleep over. It’s a natural and normal part of how markets work.  Even if this is the beginning of a more significant longer market decline, eventually it will end and markets will begin to turn around.

Know also that most portfolios are created with these types fluctuations in mind. That’s why I talk with my clients about their risk tolerance and income sources at our review meetings, and focus so heavily on their investment time horizon. It’s also why I often use dividend stocks, dividend funds, balanced funds, fixed income investments, and other “lower volatility” types of investments in most client portfolios. Such asset allocation strategies don’t completely avoid market volatility, but they can soften the blow so that you are able to ride out these market swings and in a better position to recover when markets turn around.

If you’d like a second opinion, feel free to contact me.