The 9-year bull market recently began showing some cracks with the major stock market indices falling into correction territory (An official market correction is defined by a 10% decline). Market volatility has also increased significantly.
Is the worst over? It is too soon to tell. There will always be economic and political challenges to deal with. But history tells us that this too shall pass.
We have also been long overdue for a market correction. On average, markets decline 10% or more on an annual basis. Every 3 to 5 years markets can go down 20% or more.
When you have a longer-term perspective with your investment portfolio (defined by 10 years or more), short-term volatility doesn’t matter nearly as much. Over the long-term markets are up more than they are down. Markets go up almost 3 out of every 4 years on average.
Market corrections offer an excellent opportunity to reassess your financial situation and review your investment portfolio.
Below are 6 steps to help guide you through the market volatility:
1. Tune out the news media noise
The news media exists for one reason, to sell advertising. Fear sells. Listening to the gloom and doom may play on your emotions and cause you to do the wrong thing at the wrong time.
What the news media cares most about is attracting viewers based on the current fear-based headlines of the day. It has no understanding of your personal financial situation.
The secret to weathering market downturns is blocking out all the noise from the news media, keeping your emotions in check, and staying focused on your longer-term goals.
Action Step: Turn off the news and live your life. Let your financial advisor do the worrying.
2. Don’t try to predict the markets
Timing the market is a fool’s game that is based on luck, not skill. Any “expert” who makes the right market call today will make the wrong call tomorrow. There is countless research available on this subject.
The problem with attempting to avoid the down days in the markets is you miss the rebounds that follow. You also may never get back in. For example, most investors who bailed at the bottom of the 2008 global recession never re-entered the markets. These folks have now missed out on one of the most tremendous bull markets in history.
Staying invested through the best and worst of times has proven to the best strategy over the history of the markets.
Action Step: Rather than trying to time the markets, stay invested in a globally well-diversified portfolio.
3. Review your current portfolio risk
If you’ve let your investment portfolio ride over the 9 years without rebalancing your stock/bond mix, your stock allocation is likely much greater now than you may realize.
This means you are assuming more risk than you are likely comfortable with and exposing yourself to greater portfolio gyrations in the future. Your portfolio’s asset allocation between stocks/bonds should be mapped to your financial goals and balanced to your risk capacity level.
Action Step: Review your portfolio and make sure it’s not over-weighted in stocks beyond your comfort level.
4. Avoid index funds
In a bull market when everything is going right for the markets, index funds are an easy tool for the average investor. They were invented for the masses.
Major market index funds tend to do well during bull markets because they track closely with the major market indices. However, during market corrections and bear markets index funds also assume 100% of the downside of the market. The problem with index funds is that they are like a roller coaster with no brakes.
There is no downside risk protection built into index funds which makes them very difficult for investors to stay invested through the ups and the downs.
Action Step: For your serious money, consider a risk-adjusted investment strategy rather than an index fund.
5. Consider adding to your investment portfolio
Market corrections provide opportunities to add to your investment portfolio at a time when stocks are on sale.
When others are fearful, that is the time to take advantage. This may seem difficult to do, but it pays to be a contrarian and move away from the herd mentality of panic and fear.
If you have significant cash sitting on the sidelines that is not set aside as an emergency reserve, consider adding a portion to your portfolio. That way you can earn dividends, interest, and potential growth when the markets rebound.
One of the best ways to add money to your portfolio is to dollar cost average. Determine a regular dollar amount you are comfortable contributing to your portfolio on a monthly basis. If you can automate your regular monthly additions, even better.
This kind of strategy removes the emotion from investing, and allows you to average into the markets over time rather than attempting to predict the “perfect” time.
Action Step: Consider putting idle cash to work or establishing a dollar cost averaging plan to add to your investment portfolio on a regular basis.
6. Get a financial plan in place
This final tip is my most important recommendation.
If you have no financial plan in place, you will end up somewhere.
The majority of my clients who first come to me have never had a comprehensive financial plan developed for them. Most of their advisors have focused solely on their investment portfolio and performance.
Your investment portfolio is a critical piece of your financial life, but it should be managed in the context of your financial plan. Otherwise, you will never know if you are on track to achieve your financial goals!
The financial planning process can help you clarify your financial goals and map out exactly how to achieve those goals. The planning process is also dynamic and ongoing. It’s not a one-time event. Once I work with my clients to develop their initial personalized financial plan, we reallocate the investment portfolio and adjust the savings strategy to align with the plan.
A good financial plan should be comprehensive, covering all areas of your financial life including taxes, investments, college and retirement planning, career transition, estate planning, insurance planning, cash flow analysis, and more. There are many pieces to your financial life making it much more complex than just your investment portfolio.
Action Step: Consider working with a Certified Financial Planner™ who is also experienced in investment management. These financial advisors have a total financial life focus rather than just focusing on your investment portfolio.
During challenging times like these, the tendency can be to make emotional decisions that are not in your best interest. The above 6 tips are designed to help you make better financial decisions during difficult times and put yourself in an improved financial position.
We have experienced a long period of calm markets and low volatility. Going forward, I do expect the volatility level to increase, which is why it’s more important than ever to take action now.