What Should Investors Do in a Falling Market?

Investors should review their risk tolerance and determine if their holdings are conforming to their portfolio goals. A falling market is a good time to scoop up quality shares in companies such as Enbridge Inc. (TSX:ENB)(NYSE:ENB).

The Motley Fool

In a falling market, just about any stock will fall. However, riskier ones fall harder. Some price declines are also misaligned with good business performance.

One thing that self-directed investors should do in a falling market is to review their portfolios.

Are you taking on too much risk?

Investors shouldn’t just look at the percentage of price declines to determine if they’ve taken on too much risk.

Instead, investors should check the business performance of their holdings and see how they’re faring. Pretty much any business that has exposure to Alberta or to resource industries will be experiencing price declines. However, that doesn’t mean those are poor businesses.

For example, we all know the Canadian banks are some of the best businesses you can buy on the Toronto Stock Exchange, yet some of them are selling at a 20% discount compared with their historical trading levels. Namely, I mean Bank of Nova Scotia, which yields 5% as a result of the price decline. Even though it’s a quality business, that still doesn’t change the fact that it’s exposed to the oil and gas industry to an extent.

You might have bought some energy stocks such as Suncor Energy Inc. (TSX:SU)(NYSE:SU) and Enbridge Inc. (TSX:ENB)(NYSE:ENB) in this low commodity-price environment, and they have continued their way downwards. So, you may be increasing the risk of your portfolio by buying more. If the oil price continues to head lower or if it stays low for an extended period, how will your energy stocks fare?

Do your holdings still match your portfolio goals?

In any case, if you’re diversifying into quality companies in different industries that earn stable earnings, your portfolio overall should be all right in the long term. The last year has shown that most energy companies don’t earn stable earnings because their earnings are based on the underlying commodity prices.

A falling market is as good a time as any to review whether or not your holdings still match your portfolio goals. Do you have a focus on income or capital gains? Perhaps you want to maintain a portfolio yield of 4-5%. Perhaps you intend to get a return of 7% per year over the long term.

If you’re focused on income, see which of your holdings are maintaining and/or increasing dividends according to your income goals and income-growth goals. Some businesses don’t grow their dividends, but pay an above-average yield, such as real estate investment trusts like NorthWest Health Prop Real Est Inv Trust (TSX:NWH.UN).

If you’re more focused on capital gains than income, see which of your holdings continue to grow earnings at a high rate, such as Alimentation Couche-Tard Inc. (TSX:ATD.B) and Starbucks Corporation (NASDAQ:SBUX).

Investors should be careful about high-growth companies such as Couche-Tard because their higher multiples would contract if their high earnings growth start to slow down even from double-digits to single-digits. In extreme cases, their price would go sideways or even decline.

Conclusion

It’s a good time to review your holdings to see if they’re matching your portfolio goals in a falling market. At the same time, you can determine if you’re taking on too much risk and tweak your actions, so you can take advantage of lower prices in a falling market.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning 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 richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng owns shares of Enbridge, Inc. (USA), NORTHWEST HEALTHCARE PPTYS REIT UNITS, Starbucks, Suncor Energy, Inc. (USA), and The Bank of Nova Scotia (USA). David Gardner owns shares of Starbucks. Tom Gardner owns shares of Starbucks. The Motley Fool owns shares of Starbucks. Alimentation Couch-Tard is a recommendation of Stock Advisor Canada.

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