Extreme stock market volatility this year has tested the nerves of even the most experienced, battle-hardened investors. Markets plunged back in the spring as the scope of the coronavirus pandemic became apparent, only to come roaring back over the summer and fall as government stimulus programs took effect and the Federal Reserve pledged to keep interest rates low for the foreseeable future.
These kinds of stomach-churning highs and lows can leave investors feeling helpless and out of control. In this condition, you could be more vulnerable to making emotional investing decisions that aren’t in alignment with your long-term financial objectives.
As COVID-19 cases continue rising in many parts of the country, there’s a chance that this volatility could continue into the new year and beyond. Here are 4 suggested strategies for dealing with heightened market volatility.
- Re-examine your investing timeframe. This is a critical factor when it comes to what kinds of investing moves (if any) you should make in light of market volatility. The longer your investing timeframe, the more time you’ll have to recoup any losses you might suffer in the short term.
Remember that the stock market tends to offer the highest potential returns over the long term. For example, since its inception in 1926, the S&P 500 has produced annual returns of about 10%, while the S&P 500’s annual return has been about 8% since 1950. So if you have a long-term time horizon, such as retirement, it’s usually best to ride out periods of short-term market volatility.
- Don’t make emotional investing decisions. Unfortunately, some investors let their emotions get the best of them and sell securities during market downturns. While this might be emotionally comforting, it can be costly if it causes you to miss a market rebound.
For example, the Dow Jones Industrial Average bottomed out at 18,591 on March 23, plunging nearly 11,000 points in just over a month. This was certainly frightening, but an investor who sold securities on this date would have missed out on the subsequent rebound which has seen the Dow nearly recoup all of this loss.
Similarly, the S&P 500 fell from 3,386 on February 19 to 2,237 on March 23. But it has now surpassed the level it was at in February, crossing the 3,500 level in early November — a remarkable bounce back in just eight months.
- Decide whether you need to rebalance your portfolio. Times of heightened market volatility often require that portfolios be rebalanced more often than usual. You want to determine if market changes have knocked your desired allocation of assets in your portfolio between stocks, bonds and cash equivalents out of whack. If so, you may want to sell some assets and purchase assets in a different class to bring your asset allocation back into the proper balance.
For example, suppose your desired asset allocation is 60% stocks, 30% bonds and 10% cash equivalents. However, due to market movements, the allocation is now 50% stocks, 40% bonds ad 10% cash. To bring the allocation back into alignment, you would sell some of your bonds and use the proceeds to purchase stocks until your portfolio is back to a 60/30/10 asset allocation.
- Reassess your risk tolerance. It can be easy to say that you have a high level of risk tolerance when stock markets are setting new records month after month like they had been before the pandemic. But plunging markets can serve as a reality check in terms of what your risk tolerance really is.
If high levels of market volatility make you nervous and keep you awake at night, you may have a lower level of risk tolerance than you thought. In this case, you might want to consider shifting your portfolio to a lower-risk asset allocation that’s lighter on stocks and heavier on bonds and cash equivalents. But if you’ve been able to survive this year’s heightened volatility without losing too much sleep, then you may be fine with a higher percentage of stocks in your portfolio — especially if you have a long-term time horizon.
Give us a call if you have more questions about dealing with market volatility. We can help you implement strategies based on your timeframe, risk tolerance and other factors.