Despite the inevitable anxiety that accompanies it, stock market volatility can be beneficial. Corrections are a normal and essential part of the cyclical nature of the market, serving as a “pressure release valve” when stock markets roar too fast.
During the 17-month bear market that occurred between October 2007 and March 2009, the S&P 500 plunged nearly 57%. However, he bounced back in a big way, ending 2009 with a 26% gain. More recently, during the initial month of the COVID crisis (from mid-February to the end of March 2020), we saw the Dow Jones Industrial Average lose 37% of its total value and then recover 43.7% at end of the year. .
The bond market has also experienced notable volatility. From January 2021 through the spring of this year, the Bloomberg Global Aggregate Index, a benchmark for government and corporate debt, fell 11%, a record for global bonds.
These are the types of market swings that can test investors. A comprehensive plan can help paint the big picture, refocusing on the long term and outlining the many factors that go into reaching your goals, not just the returns on your investment.
So what should you consider when navigating market volatility?
1. Keep your focus on the long term
Over the years, those who have committed to weathering the storm, remaining disciplined and focused on their long-term investment plan when markets turn volatile, have ultimately been well rewarded for their patience.
History has repeatedly shown that it is not your time in the market, but your time in the market that is the primary driver of investment growth. While some may seek the calmer waters of cash, volatility-induced stock declines (particularly in the face of strong earnings data) offer an opportunity for long-term investors to drive down the average cost of their shares through the average of the cost in dollars. Dollar cost averaging is when you invest the same amount of money in a particular security that repeats itself over a certain period of time, regardless of price. This means that if the price of the security goes down, your same monthly investment can buy a larger number of shares.
While extreme volatility may cause investors to drop out of the market and sit on the sidelines for a while, that strategy is worth reconsidering. A recent study by investor research firm Dalbar examined the average return achieved by investors over the past 20-year period and found that while most try to time the market, they have significantly underperformed the market as a result. . Amid strong index returns, the average investor over that period has underperformed a simple indexed 60/40 portfolio by 3.5% per year. On a $100,000 investment made in early 2001, that means more than $170,000 of profit would have been lost by the end of 2020.
2. Keep cash on hand and pay off high-interest debt
While you can’t control the markets, you can control how well you’re prepared to navigate rough waters. Make sure you have an emergency fund set aside to cover at least six to 12 months of living expenses. This can help protect you from having to liquidate investments at depressed values to generate the necessary income, while providing the ability to take advantage of lower prices after a recession.
If possible, pay off most of your higher-interest debt (for example, credit cards, car loans). But not at the expense of tapping into your emergency fund. The goal is to insulate yourself as much as possible from other financial stressors when markets become volatile so that you are less likely to have impulsive reactions that could lead to poor financial decisions.
3. Don’t put all your eggs in one basket.
A diversified portfolio is a key factor in navigating volatility. Allocating your assets to a variety of investment types can be helpful in reducing risk.
It starts with asset allocation, the act of dividing your investments among different assets, such as stocks, bonds, and cash. There is no set standard for how and where to allocate your assets. Instead, it is unique to each investor, taking into account key factors in their individual financial landscape, such as the time frame they have to achieve their goals (for example, retirement) and their preferred risk tolerance.
From there, it is important to further diversify within each asset class. For example, make sure that if you’re investing in the bond market, your bond portfolio isn’t concentrated in one area. This allows you to be better protected during volatile times, minimizing risk if all your holdings are not at a specific value.
Also, if you’re considering converting some of your traditional IRA assets to a Roth IRA, a market downturn (when the value of those assets has gone down) may be an opportune time for a Roth IRA conversion, since the taxes you’ll pay it can also be less. Of course, Roth conversions aren’t for everyone, so be sure to check with your tax advisor before taking any action.
4. Rebalance carefully
Over time, during a period of extended market gains, a portfolio invested in 60% stocks and 40% bonds, for example, could see its stock allocation rise steadily to 75%, while its holdings bonds fall 25%, due to stronger performance of stocks relative to bonds. This may cause you to take more risk than you intended or needed based on your long-term goals.
That’s why it’s important to regularly rebalance your portfolio. Instead of regularly buying and selling stocks in a way that generates capital gains, there are several rebalancing strategies that can help minimize potential tax consequences:
Think minimal. Consider setting a minimum threshold for rebalancing. This can help your portfolio absorb some of the short-term market volatility without triggering buy or sell transactions.Consider the big picture. Don’t look at individual portfolios (taxable and retirement) in a vacuum. Even if target allocations in your taxable portfolio drift beyond acceptable risk limits, they can be offset by a reallocation of assets within your retirement accounts with no tax impact.Be strategic about RMDs. If you’re age 72 or older and take required minimum distributions (RMDs) from your retirement account(s), you may be able to rebalance by withdrawing your highest-earning investments.Donate wisely. Those who wish to contribute to a charity may consider gifting highly prized stock. It is a simple but effective way to restore target allocations without the need to sell shares.
The bottom line: stay focused on your financial plan
Warren Buffett once said, “If you’re not willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”
Remember that volatility will come and go. But when you’re armed with a well-constructed long-term portfolio, anchored in a comprehensive financial plan, you can feel more confident about staying on track toward achieving your long-term goals. And don’t be shy about seeking help from financial professionals. We are always here to help provide advice and guidance as you work towards your goals, especially during volatile times.
This article was written by and presents the views of our contributing advisor, not the Kiplinger editorial team. You can check advisers’ records with the SEC or FINRA.
Vice President and Director of Estate Planning, Janney Montgomery Scott
Martin Schamis is the Head of Wealth Planning for Janney Montgomery Scott, a full-service financial services firm that provides comprehensive financial advice and services to individual, corporate and institutional investors. In his current role, he is responsible for the strategic direction of the Wealth Planning Team, supporting more than 850 financial advisors who advise Janney’s private retail client base. Martin is a Certified Financial Planner™ Professional.
Source: www.kiplinger.com