The first four trading days of 2016 were the worst to start a year in the history of the S&P 500, and the volatility continues to take investors on a roller coaster ride as January grinds on. In the face of that kind of downward pressure, and the ensuing onslaught of negativity in the media, it can become extremely difficult for investors to keep a level head. The bad investor behavior traits that tend to derail long-term portfolio success are hard to beat back in times like this, but with that goal in mind, here are a few strategies that might help investors maintain their resolve and weather the tough times.
1. Have a plan
The benefits of a well-thought-out financial plan cannot be overstated. By focusing on your short-and long-term goals, and creating an investment strategy designed to address those specific issues, you can greatly increase the chances of staying on target during times of heightened volatility. Studies show that clients with a financial plan in place are much better prepared for the important financial milestones that concern most of them, which, in turn, significantly increases their odds for success. For example, an international HSBC study, “The Future of Retirement in 2011”1, showed that those with financial plans accumulated nearly 250% more retirement savings than those without a financial plan in place. Furthermore, nearly 44% of those who have a financial plan in place save more money each year for retirement. Have a plan, and stick to it.
2. Diversify your investments
It’s amazing how often we see a new client walk in the door, and show us a portfolio consisting almost entirely of his or her company’s stock, without any sense of how precarious this situation can be. The client’s income, benefits, investment portfolio, and even retirement account balances all depend on the health of her employer. In essence, the person’s entire financial life is tied to that one company, and regardless of how great the widget that company makes might be, it can backfire in a big way. Just ask the former executives of once-great companies like Enron or Lehman Brothers. The adage “Don’t have all of your eggs in one basket” is as old as investing itself, but it is not always easy to keep top of mind. The outperformance of U.S. Stocks over many other asset classes during the bull market during the past five to six years caused many to question the effectiveness of a diversified portfolio strategy. I recall a client back in May asking if he should divest completely from bonds due to the likelihood of a Fed rate increase and his reading that suggested an inevitable steep drop in bond prices. As of January 19, 2016, the S&P 500 (SPY) was down 7.9% and the Barclays Aggregate Bond Index (AGG) was up .9% for the year. As is usually the case, the arguments for discarding time-tested long-term strategies due to short-term dislocations, tend to falter under the weight of time.
3. Don’t try to time the markets
If the ‘great recession’ taught us anything, it is that markets tend to rebound when you least expect them, and they tend to do it quickly. In March of 2009, the S&P 500 was at 666, and no one seemed to know just how low it might go. By September of 2009, just six months later, the S&P 500 stood at 1025, an increase of over 50%. Staying invested in the face of downward momentum may take a strong stomach, but bailing out with the idea that you will jump back in once the market turns, is a recipe for disaster. First, by getting out while the market is falling, you turn paper losses into real losses. Second, since picking the actual bottom is extremely difficult, if not impossible, you are likely to suffer the doubly-whammy of missing out on the best of the rebound as well.
4. Turn Volatility into Opportunity
It never feels good to see the value of your investment portfolio dropping, but this kind of volatility can actually be a good thing for many investors. Let’s say you go to Macy’s and see a jacket you love that costs $100. The next week, you see the same jacket on sale for $75. Great, you think, time to pull the trigger. But, instead you decide that you prefer to wait until the price goes up to $150, and then you’ll have to have it. This makes no sense, right? Yet this is exactly what millions of investors do on a consistent basis. When the market is up, they feel great about it and cannot wait to commit more money to it. When the bear market hits, they get spooked and tend to want to wait it out until things look better. March 2009 may have been the greatest time to buy stocks that any of us will see in our lifetime, yet virtually no one wanted to invest in the face of all of that negativity. If we can understand that volatility is not only natural, but necessary, and treat it as an opportunity, by adding capital to our portfolio during times of downward pressure, we will likely be rewarded over the long-term. Better yet, if we can continually contribute on a systematic basis (dollar cost average), we can take advantage of volatility throughout all market cycles, by buying less shares when the market is high, and more shares when it is low, thus taking emotion and guesswork out of the equation.
5. Stay focused on Your Goals
By focusing on the goals we have set for ourselves (see ‘have a plan’ above), we naturally take some of the emphasis off the short-term noise, and concentrate on what we are trying to achieve over the long-term, which can help us stay the course. This is not so easy to do, particularly when the mainstream media machine gets kicked into full-on fear-mongering. Negativity bias causes us to instinctively focus more on bad news, rather than good, which makes sense from an evolutionary standpoint where we are hard-wired for survival. If we’re trekking through the woods, this instinct can be very useful, and even keep us alive; but in investing, it can be extremely detrimental. It can cause us to dwell on negative news, and potentially overestimate the risk we may be exposed to, which in turn can cause us to make emotional decisions regarding our investments – generally a very bad thing. By staying focused on our goals, and the strategies we have designed to help address them, we can take some of the emphasis off short-term events, thus increasing our ability to stomach volatility and stay on-course.
Maintaining a long-term outlook and keeping your emotions at bay during volatile markets isn’t easy. It takes a strong stomach, and for many, help from a professional as well. If you can manage it, however, the rewards may likely be significant, and keep you from falling into the same behavioral traps that have plagued so many investors for so long.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Barclays Capital Aggregate Bond Index is an unmanaged market capitalization-weighted index of most intermediate term U.S. traded investment grade, fixed rate, non-convertible and taxable bond market securities including government agency, corporate, mortgage-backed and some foreign bonds.
All indexes are unmanaged indexes which cannot be invested into directly. Past performance is no guarantee of future results.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Stock investing involves risk including loss of principal.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.