Key Takeaways
Volatility is a natural part of a healthy market cycle. Use it to your advantage.
Behavioral finance tells us the pain of a loss is felt twice as acutely as the joy of a gain. Don’t panic-sell.
The biggest gains for the market usually occur after the steepest drops. Missing out on just a few of those big days can cost you hundreds of thousands.
Over the past 50 years, the stock market has experienced multiple 20%+ declines in very short periods. Although that may sound alarming, these corrections are typically short-lived, and the market often reaches new highs soon afterward. And we can use these dips as opportunities to rebalance our clients’ portfolios by taking advantage of temporarily discounted stock prices for long-term growth.
Psychology Of Investing
We spend a lot of time with our clients on the psychology of investing. When meeting new clients, we stress three components of a proper investing strategy:
Diversification.
Investment Selection (or "Asset Allocation”).
Investor Behavior.
Psychology plays a big role at each stage because it's natural for people to feel anxious when markets drop. My colleagues and I do, too. We know that market drops are inevitable, but it’s still not a good feeling to see share values and indexes decline so abruptly. Behavioral finance tells us the pain of a loss is felt twice as strongly as the joy of a gain, so don’t succumb to panic selling.
The weekend that President Trump announced tariffs on China, Mexico and Canada, a few of our clients with high-powered careers instructed me to start going to cash and reduce their stock exposure. The Monday that the market opened, the broad market was down 1.5% but by midday it was neutral and suddenly their nerves calmed. If I had acted immediately on their sell instructions without a discussion, the changes to their portfolio could have had a lasting impact on their financial plan.
As I write this piece, the original 30-day tariff extension has passed, and the market has been reacting negatively. It is possible the market will continue to slide as investors try to navigate tariff fears, but it is also possible it will remain stable. That’s why it’s important to have an advisor. Otherwise, panic selling essentially locks in losses permanently rather than letting the market do its work for you.
I can’t tell you how many times I’ve heard people say: “I’m going to cash and I'll get back in once the markets recover.” Even highly accomplished investors can succumb to their emotions (and sensational media headlines) during stressful times. The problem is that the market never sends you a memo when it’s safe to get back in. If you miss out on just a handful of the best days in the market – they usually occur shortly after steep drops – your portfolio almost never recovers.
As the chart below shows, the average equity investor who jumps into and out of the market will significantly lag a disciplined investor who stays fully invested regardless of the market’s ups and downs. Over a 30-year period, the average equity investor who started with $100,000 would end up with about $1 million. That’s a respectable 8.01% annual rate of return. However, if they had stayed fully invested over that same 30-year period, they would have over $1.8 million – a 10.15% annual rate of return. That’s an $800,000 difference! Think of what you could do with an extra $800K!
Strategies To Stay Calm
Staying calm in the face of market volatility becomes easier with a well-structured plan. That’s another good reason to have a qualified planner on your side. We can implement a well-structured investment strategy for you that assumes there will be volatility from time to time. If the portfolio is built around long-term goals, short term dips should not cause panic. A properly diversified portfolio will spread that risk across the globe from stocks to bonds to real estate in many different industries and counties. This reduces your overall exposure to volatility. It doesn't mean your portfolio will never go down, but it does mean you'll have a much smoother experience than if you’re only invested in large U.S. stocks.
Another key strategy is rebalancing. As mentioned earlier, market swings will shift your portfolio and your original allocation can become skewed: stock allocations may shrink when markets drop and expand when they spike. By rebalancing, you regularly realign your investments to their target proportions. Over time, this practice can help improve returns while managing risk.
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Should We Make Changes?
Market volatility is usually not a reason to make changes to your plan, but major life changes such as job loss, divorce, serious illness or retirement can be. I just met with a working couple who has been investing very aggressively in their retirement accounts because they want as much growth as possible. Their risk tolerance, however, does not align with their current strategy for the long term. In fact, they just informed me they're planning to retire in a couple years – much earlier than I expected. Based on where the market is now, my recommendation was to pull back on some of that risk by reducing their allocation to stocks and by increasing their allocation to bonds and cash. Doing so will keep them on track to reach their goals without exceeding their new risk tolerance.
As life circumstances change, we often give clients another risk tolerance questionnaire to see how much they’ve changed from when they first started working with us. If volatility at this stage of life causes too much stress, we need them to dial back on risk assets so they don’t succumb to panic selling – and avoiding our advice -- during the next market correction.
Conclusion
Stock market volatility is inevitable. It’s been around as long as we’ve had financial markets and it shouldn’t keep you up at night because volatility is a natural part of investing. Maintaining a well-diversified portfolio, avoiding emotional reactions to the headlines, and sticking to your financial plan no matter what’s in the headlines will keep you on track toward your long-term goals. If you're feeling uneasy about the markets, reach out to your planner so they can provide expert guidance and ease your uncertainty. Reach out any time. I’m happy to assist. Navigating Market Volatility
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