Investing in the markets can be unnerving at times. At the time of this writing, the broader US stock market is in a “bear market” – down at least 20% from its most recent high – and the tech-heavy Nasdaq index is down over 34%.
Looking back over time, we can see that major market downturns happen about every 7-10 years. With the exception of the quick drop and rebound in March 2020, when the Coronavirus pandemic erupted, it’s been over 12 years since American investors experienced a market like the one we’re in now. You’d have to go all the way back to the Great Recession of 2007-09 for anything comparable.
Though it’s unusual, the stock market and the bond market can both turn negative at the same time. Depending on what triggers the market downturn, and how widespread it is, it may seem like there’s no “safe harbor” available.
So, what can an investor do at a time like this? Let’s look at five smart things you can do with your portfolio in a volatile market.
Check Your Investment Mix
Research has shown that the primary driver of your portfolio’s performance is its investment mix, often referred to as its asset allocation.
If your portfolio is properly diversified – more on this below – then you can safely assume that investment risk and expected return are related. What does that mean? Simply that if you’ve allocated a higher percentage of your portfolio to stocks, you can, over time, expect higher returns.
But, how much return is enough for you? Obviously, 8% is better than 6%, and 6% is better than 4%. But, we know that a portfolio that’s generating more return is likely also riskier than one generating a lower return. And investors generally don’t like risk, particularly when it shows up as negative returns.
At Springwater, we believe you shouldn’t take any more risk with your portfolio than is necessary to meet your goals. So, confirming that your investment mix is appropriate starts with revisiting your financial plan and its goals. If you and your advisor still believe that your asset allocation is the right one for your plan, then the best thing to do now is ride out this period of market turbulence.
Diversify, a Lot
You may have heard or read about the benefits of diversification. But maybe you’re not 100% sure about what it entails.
In a nutshell, diversification is a strategy that smart investors use to allocate (or divide) their portfolio across different types of investments – commonly called “asset classes” – that are expected to perform differently over time.
If you knew in advance which particular investment was going to perform best for the coming week, month or year – that is, you had perfect foresight, or a crystal ball – you’d naturally put every penny you have into that one “best performing” investment.
Of course, no one has a crystal ball or can predict the future. While it’s true that a diversified portfolio won’t produce a return equal to the best-performing asset class, it also won’t produce a loss equal to that of the worst-performing one. In fact, investment professionals and academic researchers agree that proper portfolio diversification can help reduce portfolio risk.
The goal is to diversify both across and within asset classes. In short, this means that we want to (a) include as many asset classes in our portfolio as is reasonably possible, and (b) include as many securities within each asset class as possible.
You can read more about how to build a properly diversified portfolio here.
Rebalance, but Don’t Trade in a Panic
When you first create your investment mix – ideally as part of your financial plan – you’ll have a target asset allocation. It will be built to help you achieve your financial goals – like retirement, college for kids or grandkids, travel, charitable giving, and so on.
Because your well-diversified portfolio will contain investments that perform differently over time, you’ll periodically want to review your actual allocation, and then place whatever trades are needed to bring it back to its target. Why? Because a portfolio that has drifted too far from its target has (potentially much) different risk and return characteristics than the target – possibly too conservative, but perhaps too risky.
Academic studies have shown that annual rebalancing is generally sufficient, and that there’s not a consistent benefit to more frequent rebalancing, like quarterly or even monthly.
But, what about when there’s a period of high market volatility, like we experienced in the first quarter of 2020, or that we’re experiencing now? Well, that can represent an opportunity for an “out-of-cycle” rebalancing, to take advantage of the fact that certain asset classes may be “on sale”.
But, opportunistic rebalancing isn’t the same as selling in a panic when the market drops precipitously. So, resist the impulse to sell investments that belong in your portfolio but that may have fallen in price. Be objective and disciplined when reviewing your investment mix, and if you can’t, strongly consider hiring a qualified, fiduciary investment advisor.
Keep focused on the long-term
At Springwater Wealth, one of our favorite sayings about successful investing is, “Short-term bumps in the road are the price you pay for long-term growth”.
Most investors need to earn returns on their investments that exceed future inflation, and the ability to tolerate short-term gyrations in the value of your portfolio is an unavoidable part of that process.
Forget the Crystal Ball
When the markets are volatile, it can be tempting to try to “time” the market, by looking to sell before the market drops, and buy before it recovers. With perfect foresight, or a crystal ball, this would be a great strategy.
Unfortunately, no one has a crystal ball. So, at best, you’re speculating (code for “guessing”). And speculating is most definitely not the same thing as investing.
There’s never a clear signal about when to get out of the market. And the bottom of the market – the low point before it starts to recover – can only be determined in hindsight.
A successful market timing strategy has to be right twice – first, when to “get out” of the market, and second, when to get “back in”. Needless to say, this is virtually impossible to do consistently.
Astute investors know that long-term investing success is based on time in the market, and not on timing the market.
As Dolly Parton has said, “If you want the rainbow, you gotta put up with the rain.”
Getting Help From an Advisor
If you’re managing your own investments, and struggling with asset allocation, rebalancing, or managing your emotions, consider working with a Certified Financial Planner™ (CFP®) professional. Advisors who hold this designation had to meet rigorous educational, experience and ethics requirements.