This week, US markets suffered their worst weekly performance of 2015, leaving the S&P 500 Index in negative territory for the year after being up nearly 6% during its mid-July peak. So, as an investor, what, if anything, should you do about it?
Research shows that emotional selling, cashing out of investments because things are scary, is too common. This is problematic because investor behavior and poor decision-making can adversely affect returns. A study released in 2014 showed that the average individual equity investor had a 20-year average annual total return that was 4.20% less than the index, directly related to poorly timed decision-making.*
Here are five things you can do to take the emotion out of your investment strategy when markets get choppy:
1) Turn off the financial news
I know, this may sound strange, but as we all know, the news media thrives on negative news and fear. And I fully realize, this fear is real, as we all vividly remember the 2008 recession. However, market corrections are a natural part to investing.
2) Know the history
And this takes me right into the history of stock markets. Since 1900, there have been 35 declines of 10% or more in the S&P 500. Of those 35 occurrences, or “corrections”, the index fully recovered its value after an average of about 10 months. With that perspective, if your investing time frame is years or even decades from now, it may be best to sit tight and stay invested. Of course, recent fluctuations have not put us in correction territory for the S&P 500 right now, but since we haven’t seen a correction since 2011, many are saying it might be time. And there’s no guarantee that the length of future recoveries will happen in a similar time frame, or at all. But unless you have a need for the money in the short term, consider just being patient.
3) Look at market corrections as a buying opportunity
Historically, market downturns present some of the best opportunities to buy Investment funds at a discounted price. I realize emotionally it is difficult to look at it as a “seasonal mark down or sale”, but when a stock or stock fund share price goes down, it may actually be a good time to buy. What does that mean in simple terms: If you are contributing to a retirement fund, such as a 401(k) or IRA, or you are investing to save for college tuition down the road, corrections are a good time to increase your contributions.
4) Make sure you are properly allocated
I always mention this in my posts or in conversations, but periodically, you should revisit your portfolio to make sure it’s aligned with your time horizon and financial goals.
By developing a balanced portfolio of investments, you make sure that not all your eggs are in one basket. This is known as asset allocation. A portfolio that mixes a variety of asset classes generally has a lower risk for a given level of return. Although it cannot guarantee a profit or protect against a possible loss, asset allocation, or diversification, can help spread the risk of investing because it broadens your investment base.
5) Remember to rebalance
Having a mix of assets that works best for your situation is an important part of investing. Over time, however, market moves can affect the allocation of your assets. For example, because of outsized market performance since the end of the Great Recession, your portfolio may have become too exposed to stocks for your goals. Therefore, you might be taking on more risk than you realize and should consider taking some of your gains off the table and reallocating them to less volatile fixed income. That’s called rebalancing. We recommend and assist our clients with rebalance on a quarterly basis.
Market Timing Reminder
The question always begs itself: Should you sell out of this market and go all cash? No. While moving to cash might feel good mentally and help you avoid short-term stock market volatility, it is unlikely to be a wise move over the long term.
Here’s why: When your money is in the stock market and the market is down, you may feel like you’ve lost money, but you really haven’t. At this point, it’s a hypothetical loss, on paper only. A turnaround in the market can put you right back to breakeven and maybe even put a profit in your pocket. If you sell your holdings and move to cash, you lock in your losses. They go from being paper losses to being real losses with no hope of recovery. And then you’re in the hole, forced to make up for your losses just to get back to square one. While paper losses don’t feel good, long-term investors accept that the stock market rises and falls. Maintaining your positions when the market is down is the only way that your portfolio will have a chance to benefit when the market rebounds. And remember, no market moves in the same direction forever.
When you sell your stocks and put your money in cash, odds are that you will eventually reinvest in the stock market. The problem then arises, however, of trying to figure out when to jump back in. Trying to choose the right time to get in or out of the stock market is referred to as market timing. If you sold out of the market when stocks were tanking, that means you weren’t able to predict a peak. It’s therefore highly unlikely that you’ll be any better at predicting a bottom and buying before things start moving up again. The lesson to learn here is that it is exceedingly hard to call both a top and bottom to a market cycle. The better approach is to ride out the ups and downs instead of dealing with the toll that inflation and opportunity cost can have on an all-cash portfolio.
Remember that investing is a process, not an event. Please do not make rash moves in response to market cycles. Although you cannot control what happens in the stock market, you can control how you prepare and respond. Market ups and downs are part of investing. The important thing is to stay invested, remain patient and have a plan. If we can assist you in any ways, please do not hesitate to call us at 480-729-6240. We would be happy to discuss your risk tolerance, financial and investment goals and time horizon.
*Source: DALBAR, Quantitative Analysis of Investor Behavior, 2014. Dalbar.com
Past performance cannot guarantee future results. No investment strategy can eliminate the risk of losses. Asset Allocation, rebalancing and diversification are investment strategies used to help manage risk. They do not ensure a profit or protect against a loss.