2 winners and 2 losers during a stock market downturn

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Investors don’t need to panic in the event of a market downturn. It is important to find the best strategy to navigate through difficult times. As always, there will be winners and losers in this volatile time.

You can transform your long-term performance by adopting winning strategies and not losing any now. Here’s how.

Winner 1: Investors with “dry powder”

It hurts to watch the value of your portfolio during a market downturn, but now is not the time to bury your head in the sand. Corrections are huge opportunities for investors who have cash to deploy, known as “dry powder” in the financial industry. Stocks have become much cheaper relative to the sales, cash flow and dividends of the underlying companies. The downturn is like stocks are selling, and it’s the best time to buy.

Image source: Getty Images.

Of course, it takes a combination of luck and foresight to grow that stack of cash. Most asset managers keep part of their portfolio in cash. The amount of cash tends to go up and down depending on the manager’s opinion of the viability of the investment. Warren Buffett holds a huge amount of cash at Berkshire Hathawaybecause he determined that the stocks were overvalued relative to their fundamentals.

Investors shouldn’t have been completely out of the market before this latest downturn. However, those who have been careful not to get carried away with the fervor should have cash on hand to take advantage of more attractive prices.

Winner 2: Dividend Stocks

Dividend stocks aren’t immune to market downturns, but they tend to outperform other stocks during tough times. Corrections and bear markets are signals that investors’ risk appetite has diminished. Uncertain conditions cause capital to flow away from equities and into other asset classes like bonds and cash.

These same forces are also at work in the stock market. Growth stocks tend to take a beating, while dividend stocks hold up a bit better. Companies that pay dividends also tend to have more stable cash flows and often avoid catastrophic disruptions during economic turmoil. It’s important to note that dividend-paying stocks still provide returns in the form of quarterly distributions, even if their stock prices are temporarily down.

This is playing out as we speak. the Vanguard High Yield Dividend ETF is up about 2% since the start of the year, while the main stock indices have fallen. Growth stock valuations have gotten a bit out of control and investors are looking for safety as prices fall back to historically normal levels.

^ SPX Chart

Data by YCharts.

Loser 1: Investors who sell

The only people who really lose during a stock market downturn are investors who sell their stocks. Gains and losses are not realized until they are blocked by a sale. Any position with positive returns can still swing into a loss until that position is closed – the same goes for positions that are down.

In the history of the stock market, each downturn has been only a temporary divergence from a long-term growth trend. If you are selling during a downturn, you are buying high and selling low. You lose your chance to capitalize on growth when the market recovers in the future.

But investors sell for all sorts of reasons. Some stocks are sold to cover distributions from retirement accounts. Sometimes circumstances change in a financial plan and assets need to be liquidated to meet cash requirements. Or a portfolio needs to be rebalanced to get a better mix of growth and volatility.

Too often, however, investors make decisions based on fear and exit the market due to the risk that losses will increase even further. Selling in a downturn can help you avoid the impact of a full-blown bear market if it goes that far, but it’s nothing compared to the opportunity cost of missing out on any future gains.

The best investors understand that volatility is inevitable and they don’t throw away their entire investment plan when the market goes through a tough time.

Loser 2: Growth stocks

Growth stocks are generally great tools for long-term returns, but they come with added volatility. They outperform when the market is bullish and underperform when the market is falling.

Stock prices are theoretically based on expected future cash flows, and growth stocks have more uncertainty around these cash flows. It takes a greater leap of faith to predict future profits from a business that is growing rapidly but producing no bottom line today. The rewards are great if the story comes to fruition, but the risks are also greater.

Valuations peak at the peak of market cycles, and growth stocks tend to have the most aggressive valuations when investors’ risk appetite is high. This leaves more room for the downside when the market goes down.

That doesn’t mean investors should avoid growth stocks. Instead, it suggests that they shouldn’t be overexposed to this category and should make sure they’re ready to ride out volatility when it inevitably arises.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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