Weathering the Storm: Staying Calm and Focused in a Volatile Market
Whether you’ve just started investing or have been investing for decades, you’re going to encounter market volatility. How do you weather the storms and stay on course with your financial goals, when the market is experiencing a lot of ups and downs?
First off, what makes a market volatile? Volatility is measured by the rate of a stock price increasing or decreasing over time— if that rate is frequent or wide, then you see what we call volatility. A volatile market is characterized by big swings in value, fluctuations in price, and increased and/or lopsided trading activity in a short period of time.
I include this definition because what we, as professionals, define as a “volatile market” isn’t always in line with what investors see. As we’ve discussed before, emotion can influence investment decision making and how you think about your money. We understand investing from an intellectual perspective, developing our comprehension of risk and how it relates to the current environment. But there’s an emotional component as well, and we have to balance the two.
Nowadays, we’re also exposed to more information than ever, and that can also have an impact on our perception of the market. We have to examine the sources we use to educate ourselves about money, to make sure we’re not buying into a hype or a scare tactic.
Here are some tips for understanding — and managing — market volatility:
Understand how you’ve invested
It is important to make the connection between your objectives and their style of investing/tolerance to risk. These essential elements provide a clear foundation to allow you to maintain perspective about portfolio performance in various market cycles, including volatile periods of time. If your style is changeable and reactive, you may want to try to “time the market.” This is extremely difficult to do, even for seasoned investors, and not something we recommend. If you tend to be more risk-averse, you may feel uncomfortable with market fluctuations, but every market has some volatility.
Keep financial news and information in perspective
We’re living in an information age, and it’s important to maintain a healthy perspective on the information we receive about the markets. Often, I’ll turn on the TV or open a news website and see the following headline:
SPECIAL REPORT— MARKETS IN TURMOIL
Scary, isn’t it?
Would it surprise you to learn that since 1948, US stock has averaged an intra-year decline of 13.4%, but finished positive in 51 of 70 years? Alternatively, would it surprise you to learn that the US economy has never had a recession with US profits up?
I’m not bashing the media here. In fact, I recommend using fair and balanced, trustworthy news coverage as a means of educating yourself on investing topics and market events. But I encourage you to reflect on information you receive and develop a context for it, rather than just react with panic when you see a headline like that. Temporary trends don’t necessarily signal a market in turmoil— or that the “turmoil” will affect your investments in the long run.
At MJP, we place a high value on information. That’s why our firm collaborates and partners with an institutional Registered Investment Advisory (RIA) firm, which allows us to access accurate, in-depth data on market cycles and trends. We take the time to analyze this information so we can apply that knowledge to our clients’ investment plans. If you’re looking for ways to learn more about investing and markets, look no further: we share some of this information in digest via our blog and e-newsletter.
Stay focused on your investment priorities
Your goals dictate how you invest, and many factors play into your goals. These goals can be short-term versus long-term in nature. I define this as duration. If you’ve invested money that you need in 12 months, you will make different decisions than if you’re investing money you don’t need for another 30 years. If you’re closing a savings gap for retirement, you may need to take on more risk, but you still need a balanced, diversified portfolio to protect you from potential loss. Otherwise, more risk may create more panic when you hear that “markets are in turmoil.” Consequently, how we invest, what we invest in, what our duration is, how we think about risk and reward dynamics, how we think about volatility and what are objectives for our assets, leads an investor in the appropriate direction of deciding do I have affordability to take on risk and what should be the appropriate portfolio construction relative to an investor’s objectives.
It’s more than just understanding what you’re investing in, whether it’s college funds or IRAs or stocks or real estate properties. It’s understanding why we invest. Simply put, we invest to preserve purchasing power. We put money in vehicles that will yield returns so we can stay ahead of inflation, so we can afford to achieve our goals. Depending on the goal, determine just how far ahead of inflation you want to be — well, that’s your choice as an investor. In any case, it’s better to stay aligned with your goals, rather than react to volatility and outside forces.
Prioritize stability to guard against big losses
Market corrections are unavoidable for anyone investing over the long haul. How a portfolio weathers those downturns has a critical impact on the investor’s end destination. This is because steep market drops create large holes from which to dig out. As the loss grows, so too does the return needed just to get back to the original, pre-downturn starting point. Consider the math: A loss of 10% requires just an 11% gain to recover, while a 50% loss requires a 100% gain to recover and a 60% loss requires an even more daunting 150% gain to simply return to even.
The normal cadence of taking on risk and investing may seem like turmoil, so your investment portfolio should have the stability to guard against big losses, rather than shift with every breeze. Think about a toy sailboat vs. a 200-foot ferry — the toy boat can be moved quickly and easily, but it’s nowhere near as stable as the real one. (Nor will it carry your family on a trip to Nantucket.)
The chart below demonstrates how important it is to limit drawdowns, and mitigate volatility in an effort to enhance a client’s dollar-weighted return. Take a look:
Past performance does not guarantee future results.
Source: Morningstar. Data from 07/98 – 12/18. Volatility as measured by standard deviation.
The blue line represents the performance of the S&P 500 Index. It shows where a portfolio would end if it participated in 100% of the market’s gains, but also took full part in 100% of its losses.
The orange line represents a portfolio that participated in 60% of the S&P 500’s gains, but experienced only 40% of the S&P 500’s downside during market declines. Over time, investors would be closer to reaching their investment goals by reducing wild market swings.
What does this chart tell us? In short, it can take 6 good years to offset 4 bad years. You need to make a lot more on your investments in order to cover bigger losses.
As we navigate an ever-evolving global economy, we are conscious of all the interdependent variables that can affect markets on a daily basis, and in the long term. To weather the storms of a volatile market, remember to balance your awareness of these factors with solid information, a sensible perspective, and a focus on your priorities. And finally — make sure you have trusted professionals to advise you. We are in this business to help people, and we are honored that you, our clients, trust us to help you build your financial future. We continue to work to earn that trust, in everything we do.