This is what the start of corrections look, sound and feel like. Frankly we may be overdue for a steep sell-off but that doesn’t necessarily mean this is the start of a crash or a bear market. It’s an opportunity. Conventional wisdom says that what goes up must come down. But even if you view market volatility as a normal occurrence, it can be difficult to handle when it's your money at stake. Though there's no foolproof way to handle the ups and downs of the stock market, but the following reminders can help.
The recent sell-off isn’t even major by the standards of this bull market. In 2010 the S&P 500 index dropped 16%. In 2011 shares dropped just a whisper under 20% in response to the crazies in Washington, DC shutting down the government. Obviously the market survived.
Ultimately all the factors that have propelled markets since 2009 are in place. U.S. stocks are still the best asset choice in an uncertain world. Barring an outbreak of inflation, which doesn’t exist, the Fed will reluctantly launch another round of QE at the slightest provocation. Ebola will be contained most likely like SARS.
2. Investors are more aware of risks
The three worst performers in the S&P 500 recently were United Rentals (URI), Best Buy (BBY) and General Motors (GM). All three fell more than 5% on downgrades. Recognizing that United Rentals and GM might be facing headwinds isn’t exactly groundbreaking research. Best Buy has done a great job staying afloat but the shares were up almost 50% since April. When shareholders of these companies are willing to dump shares down 5% it’s evidence of a panic among investors, not rational thinking. Again, that’s a sign of a healthy market.
3. “Trendy” stocks are getting whacked
Recently, shares of a retailer that never should have been public in the first place and a company that makes seltzer water each fell more than 20%. It’s a sign of health. Fad stocks getting crushed is supposed to happen. It’s a sign of excess being taken out of market. That hurts but it’s healthy.
4. We don't put your eggs all in one basket
Diversifying our clients investment portfolio’s is one of the key tools we use for trying to manage market volatility. Because asset classes often perform differently under different market conditions, spreading your assets across a variety of investments such as stocks, bonds, and cash alternatives has the potential to help us mitigate your overall risk. Ideally, a decline in one type of asset will be balanced out by a gain in another, though diversification can't eliminate the possibility of market loss. One way we diversify your portfolio is through asset allocation. Asset allocation involves identifying the asset classes that are appropriate for you and allocating a certain percentage of your investment dollars to each class. To establish the appropriate asset allocation for each client we take our clients through a thorough discovery process in which we discuss their investment objectives, risk tolerance level, and investment time horizon.
5. Focus on the staircase, not the yo-yo
As the market goes up and down, it's easy to become too focused on day-to-day returns. Instead, we recommend that our clients keep their eyes on their long-term investing goals and their overall portfolio. This is best illustrated like the old yo-yo and the stairs idea. Picture a kid with a yo-yo (short-term market movements) walking up a stair case (long-term gains). Over time, the markets have always increased, but in the short-term, price movements and volatility are just a part of the process. Each investor has to decide how much investment risk they are willing to handle, if they still have years to invest, we recommend not over-reacting to the effect of short-term price fluctuations on their portfolios.
6. Look before you leap
When the market goes down and investment losses pile up, many investors may be tempted to pull out of the stock market altogether and look for less volatile investments. The small returns that typically accompany low-risk investments may seem attractive when more risky investments are posting negative returns. But before transitioning into a different investment strategy, we encourage considering if this action is being taken for the right reasons. How a client chooses to invest their money should be consistent with their goals and time horizon.
7. Don't count your chickens before they hatch
As the market recovers from a down cycle, excitement quickly sets in. If the upswing lasts long enough, it's easy to believe that investing in the stock market is a sure thing. But, of course, it never is. As many investors have learned the hard way, becoming overly optimistic about investing during the good times can be as detrimental as worrying too much during the bad times. The right approach during all kinds of markets is to be realistic. Have a plan, stick with it, and strike a comfortable balance between risk and return.