Episode 96: Strategies for Investing in Volatile Markets

Transcript

Strategies for Investing in Volatile Markets

Hello and welcome to the balanced wealth podcast. My name is Gavin DiStasi and today we’re going to talk about market volatility and discuss some strategies for maintaining your investment discipline when the volatility in markets gets cranked up.

After nearly 14 years of uninterrupted up markets, save for a few corrections along the way, the start of the year has brought back volatility and uncertainty in the markets, if not a full blown pull back just yet. And while the S&P 500 is only down roughly 3% year to date, the general feeling among investors seems to be uneasiness at the least. And it’s no wonder, with the madness being reported out of Washington every day.

But despite the uncertainty that brings, it’s vital as an investor to be able to keep some perspective when it comes to managing your portfolio, and not let those feelings of concern or even outright fear, derail your long term investing plans. The truth is that at some point, markets will get even worse than what we’ve seen recently. Whether that happens soon, in the near future or much farther down the line, is anyone’s guess, but the fact is that corrections are part of the market’s cycles, and an inevitability we all have to be prepared for to achieve the long term returns we all seek.

In light of that, here are some strategies that will hopefully help you ride out these times of increased volatility and uncertainty in the markets.

First – 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”, 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. The takeaway here – Have a plan, and stick to it.

Next – 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. For example, the outperformance of U.S. Large-Cap Growth Stocks (think big tech) over U.S. Large-Cap Value Stocks (think consumer staples) during the bull market the past five or six years caused many to question the effectiveness of a diversified portfolio strategy. However, as the market has stumbled recently, it has been those value stocks which have held up much better, and the growth stocks which have been battered instead. If we had all abandoned our diversification strategies, and piled into those growth stocks during the run-up, the pain we have been feeling of late would be much worse. 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.

Continuing on – 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.

Next Up – 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 (ie: 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.

And Finally – Stay focused on Your Goals

By focusing on the goals we have set for ourselves, when we make a plan, 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 – this is 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 of 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 an experienced financial advisor. But if you can manage it, the long-term rewards will likely be significant, and keep you from falling into the same behavioral traps that have plagued so many investors for so long.