Today's keyword for equities is "volatile." Great Britain's vote to leave the European Union (the "Brexit") is just the most recent example of sharp drops followed by a relatively rapid rally. Investors are often tempted to overreact, fearing that they will lose out if they do not act immediately.
For nervous investors, navigating volatile markets with your funds intact can seem like getting out of an Old West saloon shoot-‘em-up. Confident investors look at volatility differently, as a series of threats to be managed and opportunities to be taken. Which type of investor are you?
If you find volatile markets unnerving, here are 5 strategies to help you move from the nervous to confident investor category,
1. Keep the Long-Term Perspective – A solid long-term strategy goes a long way to calming a nervous investor. Realize that the market has ups and downs, and that some losses are inevitable. The key is not to multiply the losses with panic decisions during volatile times that neutralize the eventual gains — and history proves time and again that stocks will rise in the long term. Set up a diverse portfolio with general targets for asset allocations, and stick to your plan.
2. Assess your Risk Tolerance – You understand that markets recover but you just can't stand to watch your retirement funds plummet during a market correction. The easiest way to correct this problem: don't watch it. If you are not comfortable with tracking investments and making portfolio adjustments, seek one of the many managed accounts that handle the adjustments for you.
Target index funds are an excellent example of a "set it and forget it" philosophy. Just make sure that you do not set your targets so conservatively that you cannot meet your financial needs at retirement.
3. Do Not Time the Market – If your risk tolerance is high, you may be tempted to time the market (waiting for the exact lowest price to buy or the highest price to sell) to maximize your gains. Our advice: don't do it. Research has shown that typical investors come out on the short end when attempting to time the market instead of following a buy-and-hold strategy.
Few people do very well at market timing. Those who do, almost certainly have far more resources at their disposal than you do, and can act with far greater speed than you can. Leave market timing to those experts.
4. Keep Investing Through Down Cycles – While you don't want to try timing the market, a broad drop in stocks usually drags down the price of blue chips and other stocks of companies with solid fundamentals, making them an excellent buy.
Don't be afraid of buying during a market downturn — it's usually when the eventual return is the highest. Had you invested in the S&P 500 during the recession of July 1982, your 5-year return would have been 267%. Investments during the Great Recession in March 2009 would have returned 178%. Make sure you do your homework on the company to verify that the drop is not due to longer-term factors and that a purchase fits in with your asset mix and risk tolerance.
5. Seize Opportunities – You may be able to take advantage of other opportunities during down cycles. For example, do you have any losing investments that do not look like they will turn around? Selling them for a loss now can have a double-effect — ridding you of a poor investment and using the loss to neutralize some of the capital gains for tax purposes. Make lemonade out of lemons wherever you can.
Preparation is the key to getting through volatile markets, with a long-term plan in place and the discipline to execute it. You may still be tempted to chug Pepto-Bismol during the down cycles, but stay confident in knowing that down cycles are a natural part of the investing process and that you have a plan in place to deal with it.