Headlines are filled with panic this week after the US stock markets saw a massive sell-off leading to the UK and European markets following suit.
Shares and stock markets go up and down in value every second. However, the FTSE is said to have lost £77billion over the course of six days. With such large numbers being spoken of it’s inevitable that people are getting nervous.
Here’s a quick tear-down of how to react to a market drop such as this;
Losses in the market are only real when you sell.
Let’s say you invested £1,000 and purchased 100 shares that cost £10 each. Now, following some market wobbles those same shares are worth £7 each.
You have two options:
Option 1: Hang on to the shares and ride out the cycle – in a week, a month, or a year’s time those shares might be worth £15 each. There’s also the chance those same shares will only be worth £2 each. Your original £700 investment could now be worth £1,500, or it could be worth £200.
So there is uncertainty, but you also still own the shares. Over the longer term, it’s impossible to predict what will happen to their value.
Option 2: You sell your shares at £700 and lose £300 of your original investment.
This is known as crystallising a loss, or making the loss “real”. When you crystallise a loss you stop holding shares, and start holding cash. At that point what you have is what you have. In fact, over time that cash is likely to lose value due to inflation.
The value of the shares could increase in the future, holding onto them means you could realise any increase in value. Of course, the shares could also decrease even further in value…
But historically, over the long term, the value of the market rises and so do the stocks within it. That’s why financial planners always recommend you get in early and hold for the long term. The longer you hold the more likely you are to ride the short-term peaks and troughs.
Markets dropping makes for scary reading but these are “paper losses”, just as markets going up are “paper gains”. These fluctuations in value won’t be real until shares are sold.
If you are a pensioner, or close to retirement age, these movements can have a real financial impact. If you are young, and the money in your pension is going to be parked there for another 20 or 30 years then this market drop, in and of itself, has little impact on you. In the next 20 to 30 years we will see markets go up and down many times.