When volatility hits, keep a cool head and consider taking advantage of potential opportunities.
Periods of market volatility can trigger emotional responses in investors. When the markets are as reactive as we’ve seen lately, it can be natural to feel some apprehension, but that’s why you and your advisor have spent time developing a tailored financial plan – so that these dips, dives, rallies and recoveries can be accounted for, all while still making strides toward your long-term financial goals.
In times of uncertainty, the key is to remain focused on those goals. Certainly, how you feel about a hypothetical 10% drop could change if that drop becomes a reality. But as you prepare for market volatility or correction, trust in the planning process and review your priorities and portfolio with your advisor.
A Long-Term View
Part of the solution, although it may seem counterintuitive, is to pay less attention to the markets and more to yourself and your financial goals. If we’re honest, we know that it’s our emotional reactions to what the markets are doing that often cause us the most trouble. For example, stock investors who simply stayed invested between 2007 and 2013 almost certainly did better than those who tried to time a very volatile market. While it’s difficult in an ultra-connected age, your investment decisions should be based on your long-term goals, not what’s happening in the markets this week or next.
What You Own and Why
Now is a good time to review your individual holdings – stocks, bonds, mutual funds, ETFs – to determine if they’re still right for you. Discuss with your advisor why you bought each security in the first place and if that reason still applies. Evaluate your portfolio as a whole to determine if you are sufficiently diversified – not just in terms of stocks versus bonds but also in terms of large- versus small-cap stocks, long- versus short-term bonds, and domestic versus overseas holdings. With your advisor, consider the current environment, where volatility is likely to continue and interest rates are likely to rise over the next few years. Think about your overall time horizon, and what you expect to happen in your personal life in the near term.
Re-evaluating Risk Tolerance
A key part of paying attention to your goals also means understanding your comfort level with movements in the market. Knowing your risk tolerance – your long-term tolerance, not how you feel when the market is soaring or skidding – can provide important perspective for creating an individual asset allocation model that’s designed to see you through the markets’ inevitable ups and downs.
Your asset allocation model – the mix of stocks, bonds and cash designed to achieve your financial goals – isn’t something you set and forget. It needs to be monitored regularly to be sure it’s reflecting changes in market conditions, as well as in your personal life. You also need to stress test your model periodically to assess the likelihood that it will achieve the objectives you’ve set forth. If things are on track, fine. If they’re not, you and your advisor may have to make some adjustments – either to your goals or the model itself.
The Silver Lining
While market declines are fairly common, historically, gains have tended to follow. But you have to participate, not withdraw, to benefit from those potential gains. Investors who chose to pull their money out of equities during those down periods may have missed some of the market’s biggest gains because some of the best days came right after periods of steep decline. For example, from 1997 to 2016, missing only ten of the market’s best days would have cut your total return nearly in half compared to those who stayed invested for those two decades. Also, remember that a decline can present opportunities to buy quality investments while they’re potentially undervalued. This may enable you to invest in high-quality companies at lower prices and capture additional value.
- Selling during downturns may lock in the loss
- Pullbacks and corrections can present buying opportunities
- Fundamentally sound investments may be discounted
Staying the Course
The stock market is cyclical, and you likely will encounter numerous pullbacks and/or corrections as a long-term investor. In the long run, upturns have always been stronger than downturns.
By looking at the market over a sufficiently long period of time, we’re provided with a true testament of resiliency. When we track the overall growth the market has achieved, we learn a lesson in persistence, patience and commitment.
There is no assurance any investment strategy will be successful. Investing involves risk including the possible loss of capital. Past performance may not be indicative of future results. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Small- and mid-cap securities generally involve greater risks and are not suitable for all investors. Asset allocation and diversification do not guarantee a profit nor protect against a loss.