No doubt 2016 was again a very strange year for investors and the year can serve as a reminder that investment returns are not always rational, particularly in the short term. The chart below form JP Morgan illustrates how US stocks measured by the S&P 500 have on average experienced a 14% intra-year drop. If you are shaking your head and saying that is why I hate stocks let’s look at the other conclusion here. Despite the average intra year drop of 14% US stocks have produced positive annual calendar year returns in 28 out of the 37 years or about 75% of the time.
This article provides 6 tips on handling market volatility.
1. Don’t put your eggs all in one basket
Diversifying your investment portfolio is one of the key ways you can handle market volatility. Because asset classes often perform differently under different market conditions, spreading your assets across a variety of different investments such as stocks, bonds, and cash alternatives (e.g., money market funds and other short-term instruments), has the potential to help manage your overall risk. Ideally, a decline in one type of asset will be balanced out by a gain in another, though diversification can’t guarantee a profit or eliminate the possibility of market loss.
One way to diversify your portfolio is through asset allocation. Asset allocation involves identifying the asset classes that are appropriate for you and allocating a certain percentage of your investment dollars to each class (e.g., 70 percent to stocks, 20 percent to bonds, 10 percent to cash alternatives).
Tools and Resources:
From your 401k provider’s website you can access worksheets and interactive tools which can suggest a model or sample allocation based on your investment objectives, risk tolerance level, and investment time horizon, but your strategy should be tailored to your unique circumstances.
Target Date and Risk Portfolios:
Alternatively, as we have written about before if you lack the time, willingness and knowledge to create your own portfolio you may want to consider one of the Target Date Retirement Funds or Model Risk portfolios that are available in your plan. These “Do-It-For-Me” portfolios will attempt to allocate your investments based on either your time horizon until retirement or your willingness tolerate risk.
2. Focus on the forest, not on the trees
As the markets go up and down, it’s easy to become too focused on day-to-day returns. Instead, keep your eyes on your long-term investing goals and your overall portfolio. Although only you can decide how much investment risk you can handle, if you still have years to invest, don’t overestimate the effect of short-term price fluctuations on your portfolio.
Short-term price fluctuations need only concern you if you are close to retirement and you plan on drawing form your 401k plan for retirement income. If this is your situation you may want to evaluate the level of risk in your portfolio.
3. Look before you leap
When the market goes down and investment losses pile up, you may be tempted to pull out of the stock market altogether and look for less volatile investments. The small returns that typically accompany low-risk investments may seem downright attractive when more risky investments are posting negative returns.
But before you leap into a different investment strategy, make sure you’re doing it for the right reasons. How you choose to invest your money should be consistent with your goals and time horizon.
For instance, putting a larger percentage of your investment dollars into vehicles that offer safety of principal and liquidity (the opportunity to easily access your funds) may be the right strategy for you if your investment goals are short-term or if a long-term goal such as retirement has now become an immediate goal. But if you still have years to invest, keep in mind that although past performance is no guarantee of future results, stocks have historically outperformed stable value investments over time. If you move most or all of your investment dollars into conservative investments, you’ve not only locked in any losses you might have, but you’ve also sacrificed the potential for higher returns.
4. Look for the silver lining
A down market, like every cloud, has a silver lining. The silver lining of a down market is the opportunity you have to buy shares of stock at lower prices.
One of best benefits of a 401k plan is that it forces you into a strategy known as dollar cost averaging. With dollar cost averaging, you don’t try to “time the market” by buying shares at the moment when the price is lowest. In fact, you don’t worry about price at all. Instead, you invest the same amount of money at regular intervals over time. When the price is higher, your investment dollars buy fewer shares of stock, but when the price is lower, the same dollar amount will buy you more shares. Although dollar cost averaging can’t guarantee you a profit or protect against a loss, over time a regular fixed dollar investment may result in an average price per share that’s lower than the average market price, assuming you invest through all types of markets.
5. Don’t count your chickens before they hatch
As the market recovers from a down cycle, elation quickly sets in. If the upswing lasts long enough, it’s easy to believe that investing in the stock market is a sure thing. But, of course, it never is. As many investors have learned the hard way, becoming overly optimistic about investing during the good times can be as detrimental as worrying too much during the bad times.
The right approach during all kinds of markets is to be realistic. Have a plan, stick with it, and strike a comfortable balance between risk and return.
6. Don’t stick your head in the sand
While focusing too much on short-term gains or losses is unwise, so is ignoring your investments. You should check up on your portfolio at least once a year, more frequently if the market is particularly volatile or when there have been significant changes in your life. You may need to re-balance your portfolio to bring it back in line with your investment goals and risk tolerance, or redesign it so that it better suits your current needs. Don’t hesitate to get expert help if you need it when deciding which investment options are right for you.