The Headlines Are Scary. Your Investment Plan Shouldn't Be.

If you're following the current financial market headlines, you'll find plenty to be concerned about. There's the current conflict in the Middle East driving oil prices sharply higher. Investors are growing more concerned about a recession, with growth of U.S. gross domestic product (GDP) slowing, and inflation moving higher again. The S&P 500 (SNPINDEX: ^GSPC) and Nasdaq-100 indexes are down 6% and 8%, respectively, from their all-time highs.

It's the kind of environment that makes investors nervous, which can lead to emotional decision-making about their portfolios. That kind of decision-making can feel right in the moment, but it's usually damaging to long-term returns.

If you look back at the history of the S&P 500, you'll see several market corrections of 10% or more. In some cases, they were the product of a short-term scare. In others, they ended up being longer-term declines triggered by a recession.

Investors can be their own worst enemies

Motley Fool researchers recently studied past recessions to discover the best ways to handle investing during these down periods. In the end, stocks have (historically, at least) always come roaring back. The problem is that those returns are usually reserved for those who can ride out the highs and lows.

Image source: Getty Images.

Investors who react and move their portfolios around usually see this pattern: They get out of stocks only after the correction has happened, therefore locking in losses. They wait for the markets to calm and conditions to improve. In many cases, however, stocks have already begun recovering while they're sitting on the sidelines. They've accepted the losses, missed out on the gains, and severely impacted their portfolio's returns.

In short, history doesn't support the idea of moving to cash from a well-built portfolio during a downturn. Studies have consistently shown that investor returns are far lower over time than the returns of the investments themselves. This buying and selling activity is the biggest reason. Getting out is easy, but knowing when to get back in is where most investors destroy their long-term returns. They often stay out of the equity market longer than they should, wait too long for conditions to get back to normal, and end up missing the recovery.

Your plan for handling scary markets

Two things worth doing right now are reviewing your current asset allocation, and being honest about your true risk tolerance. With respect to the latter point, everyone is fine with risk when stocks are steadily rising. When stocks go down is when they find out how comfortable they actually are.

If you're losing sleep at night over your portfolio, you probably have an asset allocation that's too risky. Consider reducing your equity holdings and diversifying into assets such as bonds or gold. Or if you don't want to substantially pare down your stock holdings, consider dividend-paying or defensive stocks, such as those in consumer staples or healthcare.

The headlines might be scary, but your investment plan should be long-lasting.

David Dierking has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.