Emotions can aid our basic survival. They can motivate us to take action, encourage us to avoid danger and provide us with the empathy necessary to create relationships. Regarding financial markets though, emotions most certainly do not help and yet the markets move with the mass’ emotional responses. Driven by two primary emotions: fear and greed; the markets experience various levels of volatility. Of late, fear is the primary driver causing the markets to experience sharp declines. However, if you can rise above the prevailing mood of the masses, and follow the fundamentals of investing, over the long run you will succeed and even benefit from market volatility.
Investors and the market hate the unknown and the Coronavirus is a big unknown. We don’t know how many the virus will affect and when the virus will be contained. We don’t know how business, government and individual earnings will ultimately be impacted. What we do know is that the unknown has caused sharp market declines in the past and a large part of those sharp market declines are caused by emotional investors’ reactions.
Fundamental #1: Do not try to time the markets.
Watching your investment dollars fall is painful and naturally we try to avoid pain, but you cannot time the markets. Ultimately an emotional investor will end up selling at a loss and buying back in at a premium. The concept of “buy low, sell high” does not register with our emotional intellect. So despite all the evidence that staying invested is the only way to contend with volatility, some investors will enviably pull out of the market locking in their losses.
Keep in mind that in the long-term the market moves upward, but the market doesn’t simply go up in a straight line. It can feel that way, especially after a 10-year bull market, but it doesn’t. For example, the S&P 500 has averaged 10.2% annual returns over the past 25 years while simultaneously experiencing10% or higher declines in 15 years of those past 25 years. Volatility is normal. When market declines happen rapidly it is easier to see the decline and hard not be emotional. However, the only way to gain back your losses is to stay in the market. By jumping out during times of volatility you lock in your losses and miss the biggest market recovery days.
Fundamental #2: Trust your allocation.
Keep in mind how you are allocated for your own time horizon and risk tolerance. Your allocation is how much you have in the stock portion vs the bond portion vs the cash portion of your financial portfolio. All these types of investments grow and shrink differently as the market fluctuates.
Your time horizon is how long you have until you start taking income from your invested assets. For many this is the first year of retirement. Your allocation should change with time, gradually getting more conservative, as you near retirement and start relying on your investments for income. Historically the stock market’s recovery takes an average of 4.4 years. Therefore the younger you are, the more appropriate a heavily weighted stock portfolio is, as you have ample time to ride out market declines. As an older investor, you too can ride out market declines with a properly allocated portfolio. If you are currently taking income from your investments, your account should be allocated so that you have approximately 5 years’ worth of income in the bond portion of your portfolio. The bond portion is a more stable section where you can continue to draw your income from during market declines.
Your risk tolerance is the amount of risk that you are comfortable taking on as an investor. For example, if the market’s current volatility is causing you to lose sleep at night, you may not be properly allocated for your own risk tolerance. Risk tolerance is individualized and can warrant a more conservative allocation for a younger investor or a more aggressive allocation for an older investor than what statistics and probability dictate.
Fundamental #3: Focus on what you can control.
Keep in mind your overall goals. If you are holding steady, properly allocated but still worried look at what you can control. Focus on your savings. Look at your bills and how you are spending. Perhaps you have multiple streaming services and cable. Perhaps you are ordering in more than cooking. Look at ways to cut back during times of market decline and increase your savings.
As Warren Buffet once said, “The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” When it comes to investing resist the urge to act emotionally and be patient. This is when a financial planner can give you the guidance you need to maintain a long-term focus. A financial planner can help you assess and monitor your goals, time frame and risk tolerance. You can’t control market volatility, but you can reduce its impact by setting realistic goals and time horizons and by diversifying your portfolio.
