Published in the Desert Magazine
By The Cypress Group
After several years of calm, the stock market has experienced an increase in volatility and investor concern. Worries about a slowdown in China, a drop in oil prices, continued geopolitical conflicts, and fears of a global economic slowdown are a few reasons investors are nervous today.
Periods of extreme stock market volatility can be emotionally and financially trying, especially with the “noise” that can come from the financial news media. These times can lead investors to overreact to short term news and normal market movements in a way that may harm their long term objectives.
There will be years when stocks go down 20 percent, 30 percent, or more. It can be difficult to withstand such short-term pain. Studies have shown that investors tend to panic and sell at or near the bottom of market declines, causing them to miss the subsequent recovery. For example, in 1973 and 1974 the S&P 500 was down about 15 percent and 27 percent respectively. Investors who panicked and sold likely missed the subsequent recovery in 1975 and 1976 when the S&P 500 was up 37 percent and 24 percent, respectively.
A similar story unfolded after the market declines of 2000-2003, and 2008. In each case the short-term pain and fear caused many investors to sell near the bottom and miss out on strong recoveries.
An investor needs to understand before investing any money in the stock market that such periods happen and can be expected during their investment lifetime. Volatility should be planned on and planned for - it happens.
Stock Market Volatility Checklist
So how should you react during periods of stock market volatility? What should you do or should you do nothing at all? That depends. During volatile market periods we suggest reviewing the following five-step checklist:
First, Turn Off the Noise
By “noise” we refer to the often irrelevant and incessant financial news media. There seems to be endless internet, TV, newspaper, radio, magazine articles and ads that purport to “know” exactly what you should do. Turn it off.
Steve Forbes, the editor-in-chief of business magazine Forbes, is famously quoted as saying, “You make more money selling advice than following it. It’s one of the things we count on in the magazine business --- along with the short term memory of our readers.”
The quote above illustrates how different your own personal objectives are from the financial news media, especially in times of market turmoil. Financial media thrive on fear and greed driven advertising to attract marketing dollars. Be wary of putting too much faith in the recommendations of the moment by sources who don’t know or understand you.
By turning off the noise we aren’t suggesting that you ignore current financial events or relevant research, but that you follow prudent advice and sound strategies that are pertinent to your own personal financial situation and ignore the gamesmanship.
Second, Review Your Investment Plan
If you don’t have an investment plan then you should work with a qualified professional to create one. A good investment plan should serve as a guide during volatile markets and provide clarity and direction for your own personal objectives.
Your investment plan should reflect you. It should be tied to your own personal goals, risk tolerance and time horizon in a way that works for you. Looking at the whole picture can help you examine whether your strategy should be aggressive, conservative, or somewhere in between.
Third, Assess Your Cash Reserves
If you are still working and regularly saving money in your 401k or other savings plan, a market in decline may be an opportune moment to add money.
However, if you are retired and using your portfolio to provide for your income needs you should make sure you have adequate cash reserves - possibly one to two years of portfolio spending. You should keep enough in cash or other short-term investments that you can draw upon so that you aren’t forced to sell investments at a bad time.
Fourth, Make Sure You Are Well Diversified
One of the most important things you can do to help manage the risk of volatile markets is to diversify. While it won’t guarantee you won’t have losses, it may help limit them.
How do you diversify? First, consider spreading your investments among at least three core asset classes - stocks, bonds, and short-term investments. You may also want to include other assets, like real estate securities, which are not always closely correlated with the core asset classes. Then to help offset risk even more, diversify the investments within each asset class.
Fifth, Find a Comfort Level
No one feels comfortable when markets gyrate violently, but if you find yourself watching your balances too frequently, and especially if it is causing you undue stress or anxiety, you may need to reevaluate your investment mix. However, you should be wary of being too conservative, especially if you have a long time horizon because conservative strategies may not provide the growth needed to accomplish your goals.
Seeing the Present with Clarity
No one can predict the future. We believe the key, however, is to see the present with clarity. During times of volatility an investor will more clearly see the present by following our five-step checklist: Turn off the noise, review your investment plan, assess your cash reserves, stay diversified, and find the right comfort level.
If you aren’t sure what to do consult with a qualified, independent financial advisor. By following these steps and consulting with an objective financial advisor you can keep your “current self” from possibly hurting your “future self” and avoid decisions that may damage your long term goals and objectives.