The “fight or flight” instincts of humans long predate stock markets and even Warren Buffett, and many investors today are surely familiar with these basic impulses. Should you stand up to a threat and put up your dukes? Or turn tail and run away? Market volatility in 2020 has certainly posed such questions and conundrums.
What’s the best way for investors to respond to threatening, frightening, or highly volatile markets? There isn’t a nice, neat, right, or wrong answer for everyone. How an individual investor responds (or doesn’t respond) to market tumult depends on a lot of factors, according to Robert Siuty, senior financial consultant at TD Ameritrade.
One thing to keep in mind: “Even if you do nothing, you’re still doing something,” Siuty noted. Here are a few pointers for investors concerned about how to navigate the market’s twists and turns.
Stay Apprised of Market Action, But Be Prepared to Tune Out
Markets experience periods of elevated volatility due to external factors—elections, geopolitical tensions, weather, etc.—that no investor can control. Recognize what you can control.
“Doing nothing in times of high volatility and market uncertainty is generally the best course of action,” Siuty said. “During whipsawing markets, many people who check their accounts on a regular basis let their emotions get the best of them, and that’s when they make quick, irrational decisions, trying to end the pain of tumbling markets.”
Try to Avoid Selling at the Bottom of a Market Slump
When markets nosedive, some investors who find the pain too much to bear decide to unload their stocks en masse. That’s often a big mistake, because it effectively locks in losses and investors risk missing out on any market recovery.
“You see it time and time again in markets like this, when you have high uncertainty,” Siuty said, referring to the markets in early 2020. “Anxiety can translate into irrational decisions and people selling when they shouldn’t.”
Study and Learn from Market History
So-called black swan events can and do happen—whether it’s a financial crisis, a pandemic, or other major event that shocks markets and economies around the world.
The 2008 financial crisis is still a fresh, painful memory for many. But the crisis eventually passed, U.S. stocks found a floor around March 2009, and then they set off on what became the longest bull market in U.S. history. At the recent peak in February, the S&P 500 Index had soared about fivefold from its March 2009 low.
“An awful lot of people in 2008 and 2009 let their emotions get the best of them, and because of that, they ended up selling—in some cases, their entire portfolios,” Siuty said. For them, “one of their biggest regrets is they should have just stayed the course and waited for things to recover. They missed out on pretty substantial returns.”
Selling during the crisis may have provided some peace of mind, “but in retrospect, it was the wrong decision,” Siuty continued. “History doesn’t necessarily repeat. But we’ve seen this sort of situation many times over the decades, when you have moments of high anxiety and emotion that cause people to lose their focus and discipline.”
Discipline and a Long View:
Periodic Review and Rebalance
It’s tempting to get sucked into the daily market blow-by-blow, and there’s nothing wrong with checking your portfolio regularly and keeping tabs on the market from day to day. Still, try not to fixate too much on short-term gyrations. Make sure you’ve got a long-term scope.
Investors should review their financial situation on a regular basis—quarterly, perhaps, but at minimum, annually. During those reviews, assess your goals, portfolio composition, and risk level, and ask yourself some key questions:
- Might it make sense to dial down your risk exposure?
- Is it time to “rebalance” your portfolio? Consider whether it’s weighted too heavily toward a certain asset category or a certain sector.
- Should you consider shifting into assets that tend to be less volatile than stocks, such as Treasuries?
Think about difficult potential “what-ifs” for the market and how your portfolio might fare. “It’s important that you study your situation carefully and build a retirement portfolio that can withstand shocks,” Siuty said.
Generally, it’s best to stay the course. “With retirement funds or any other long-term money, you have a time horizon of years, if not decades,” Siuty said. “Over time, the market should generally do well, but when you zoom in at any particular time, you could have significant volatility and significant market drawdowns.”
Consider Three Investment Baskets:
Short, Intermediate, and Long Term
Investors seeking to construct a well-rounded portfolio may want to think in a variety of time frames: days, weeks, months, years, and decades. As investors map out their goals and devise an overall plan, they should prioritize between short-, intermediate-, and long-term goals, with different “pockets” of dollars going toward each.
Short-term assets would tend to be stable, conservative, and provide at-the-ready funds in case immediate needs arise. Examples include certificates of deposit, money market accounts, or cash. And maintain an emergency fund that covers three to six months’ worth of living expenses: food, shelter, transportation, insurance, health care, taxes, and other basics.
For intermediate-term assets, investors may want to consider some equities, but not too many. Stocks tend to exhibit higher volatility compared to bonds and other fixed-income instruments.
For long-term investing, it may make sense to ramp up exposure to equities. Though the risks tend to be higher, the potential return may be higher as well. “With a long time horizon, investors have time to weather the storm, if there is a storm,” Siuty added.
D Is for Diversification, Dollar-Cost Averaging
Another step investors can take is proper diversification: making sure portfolios are exposed to different asset classes in ways that are appropriate to their goals, risk tolerance, and other factors. For example, what proportion of your portfolio is devoted to stocks versus fixed-income assets, U.S. stocks versus international equities, or “value” stocks versus “growth” companies? These are good questions to consider. You can also seek guidance from investment professionals.
Siuty also recommended investors consider a dollar-cost averaging strategy. Dollar-cost averaging means buying shares in small chunks and on a regular basis, regardless of the price.
Here’s one way to think about it: If you load up on stocks while the market is moving up, you’ll have more shares as prices go higher. And if you load up while the market is on its way down, you may see your overall portfolio value rise when the market turns back up.
“As you systematically add a set number of dollars to your portfolios, you’re taking advantage of lower prices when market levels are depressed,” Siuty explained. Dollar-cost averaging can “help smooth out bumps and help you find the right mix of exposure between asset classes and sectors.”