What Should You Do When the Market Drops?

In most cases, the answer is to do nothing to your long-term allocation, and to do several specific things around it. Selling after a decline converts a paper loss into a permanent one and requires you to be right twice: once when you exit and again when you return. The productive responses during a downturn are to confirm that your near-term cash needs are funded so you are not a forced seller, to rebalance back toward your target, which mechanically buys what has fallen, to harvest tax losses where they exist, and to revisit whether the allocation you chose still matches the risk you can actually tolerate. Declines are a normal and recurring feature of investing rather than a signal that something has broken. The purpose of having a plan in advance is that it removes the need to make consequential decisions while under stress.

We cannot tell you what markets will do next, and any firm claiming otherwise deserves skepticism. What follows is about process and discipline, not prediction.

Why is selling during a decline usually the costly choice?

The core problem is that exiting requires two correct decisions, and the second is harder than the first. Deciding to sell is easy when markets are falling. Deciding when to buy back is the difficult part, because the conditions that would make you comfortable returning, calm markets and good news, generally arrive only after prices have already recovered substantially.

This is compounded by the way market returns are distributed. Strong recovery days tend to cluster near the worst days, often during periods of maximum pessimism. An investor who steps out to avoid the bad days frequently misses the best ones, and research on the effect of missing a small number of the strongest days over long periods consistently shows a large reduction in terminal wealth. The precise figures vary by study, market, and period, so we will not cite a single dramatic number, but the direction of the finding is robust and well documented.

There is also a well-established gap between the returns funds report and the returns investors actually earn, driven by poorly timed purchases and sales. Investors as a group tend to add money after gains and withdraw after losses, which is the opposite of what the arithmetic rewards. Avoiding that gap is one of the most valuable things a disciplined process provides, and it is a large part of why we invest systematically rather than by forecast, as described in what is systematic investing.

What should you actually do during a downturn?

The list is short and practical.

Confirm your near-term cash is funded.The single greatest risk in a decline is being forced to sell depressed assets to pay for living expenses. This is why we organize client assets by time horizon, with a Liquidity allocation covering roughly the first one to three years of cash flow. If the next few years of spending are already in cash and short-term instruments, a decline in equities becomes an accounting event rather than a threat to your life. We describe this structure in goals-based asset allocation.

Rebalance back to target.A decline pushes your portfolio away from its target, leaving you underweight the assets that fell. Rebalancing restores the target and, by construction, means buying what has become cheaper relative to your plan. It is a discipline that is easy to describe and difficult to execute emotionally, which is precisely why it should be governed by rules set in advance. See portfolio rebalancing.

Harvest losses in taxable accounts.A decline creates an opportunity that does not exist in rising markets. Selling a holding at a loss and immediately reinvesting in a similar but not substantially identical position captures a deductible loss while keeping you invested, subject to the wash-sale rules. Those losses offset gains now and can carry forward for years. The mechanics are in direct indexing and tax-loss harvesting.

Consider whether the environment favors other planning moves.Depressed valuations can improve the arithmetic of several strategies: converting to a Roth costs less tax when account values are lower, and gifting assets to family or into trusts transfers more shares for the same gift-tax cost, with future recovery occurring outside your estate. These are not reasons to celebrate a decline, but they are reasons not to waste one.

Revisit your risk tolerance, candidly.A downturn is the only environment that tells you the truth about how much volatility you can actually live with. If you are losing sleep, that is real information. The right response is a deliberate, permanent adjustment to your target allocation made with a clear head, not a panicked liquidation. Adjust the plan, not the moment.

When is acting actually the right call?

Discipline is not the same as paralysis. There are circumstances in which changes are warranted during a decline, and they share a common feature: the reason has to do with your situation, not with your forecast of the market.

Legitimate reasons to make changes include a genuine change in your circumstances, such as a job loss, a large upcoming expense, or a shortened time horizon; the discovery that your allocation was more aggressive than you understood, which should be corrected deliberately; a concentrated single-stock position whose risk was always inappropriate; or a rules-based rebalancing or harvesting trigger firing as designed. What does not qualify is a prediction that markets will fall further, a headline, or a feeling. The distinction matters because the first category is about aligning the portfolio with your life, and the second is market timing wearing a disguise.

What does a good process look like before the next decline?

The most useful work happens when markets are calm. Decisions made in advance are better than decisions made under stress, and the point of an investment policy is to specify what you will do before you need to do it.

That means setting an allocation you can hold through a severe decline rather than the most aggressive one you can tolerate in a rising market; funding near-term liquidity so you are never a forced seller; writing down rebalancing rules, whether calendar-based or threshold-based, so the trigger is mechanical; and agreeing in advance on what would and would not cause a change in strategy. It also means having a realistic expectation of drawdowns. Meaningful declines occur regularly, and a portfolio should be built with the assumption that they will happen, not with the hope that they will not. This is the same discipline we apply to institutional risk management, described in institutional risk management for private portfolios.

A worked example: two responses to the same decline

The following is a hypothetical illustration and not a projection of any actual result. Two families each hold $5,000,000 in a 70% equity portfolio when markets decline sharply.

The first family has no liquidity plan. Facing living expenses and unsettled by headlines, they sell a large portion of their equity near the bottom and move to cash. They feel relief. They then wait for clarity before reinvesting, and clarity arrives only after a substantial recovery has already occurred. They have locked in the decline and missed part of the rebound, and their long-term plan now requires higher returns or lower spending to succeed.

The second family holds three years of spending in their Liquidity allocation, so no sale is required to fund their life. Their rebalancing rule triggers, so they buy equities at lower prices to restore the target. They harvest losses in the taxable account, banking deductions they can use against future gains. They convert a portion of an IRA to a Roth at depressed values. They change nothing about their long-term allocation. When markets recover, they participate fully, and they hold tax assets and a Roth balance they did not have before.

Neither family predicted anything. The difference in outcome came from structure and preparation, not from insight. Both examples are hypothetical.

Frequently asked questions

Should I sell my investments when the market drops?Usually not. Selling turns a temporary decline into a permanent loss and requires you to time both an exit and a re-entry correctly. Unless your circumstances or goals have materially changed, the better response is to rebalance, harvest losses, and leave the long-term allocation alone.

What should I do first during a market decline?Confirm that your near-term spending needs are covered by cash and short-term holdings, so you are not forced to sell depressed assets. Everything else, rebalancing, harvesting, and planning moves, becomes easier once you are not a forced seller.

Is a downturn a good time to convert to a Roth?It can be, because converting when account values are lower means paying tax on a smaller amount while the eventual recovery occurs inside the tax-free account. Whether it makes sense still depends on your bracket and circumstances, as discussed in our Roth conversion article.

How do I know if my allocation is too aggressive?A decline is the honest test. If you cannot sleep, or you feel compelled to sell, your allocation likely exceeds your true risk tolerance. The correct response is a deliberate, permanent adjustment to your target, made thoughtfully, rather than an emergency liquidation.

How often do market declines happen?Declines are a normal and recurring feature of equity investing rather than an anomaly. A sound portfolio is constructed on the assumption that significant drawdowns will occur periodically, which is why liquidity planning and a durable allocation matter more than any forecast.

Does anyone reliably time the market?Consistently and repeatedly timing market entries and exits has proven extremely difficult to do, and the evidence does not support building a plan around it. That is why we favor rules and structure over forecasts.