Keep repeating to yourself, "I'm investing for the long term. Short-term fluctuations are an expected part of investing." Still having a difficult time remaining calm during this volatile period? Volatile markets are frustrating for all investors. Should you stay the course of an "all-weather" strategy, or should you depart from it to minimize your losses? Or, should you be more aggressive and try to profit from any downswings? These are challenging questions that are difficult to answer. However, here are some strategies that can help you during this difficult period:
- Review the reasons why you have invested. If you haven't done so yet, put your target asset allocation in writing. Indicate why you have adopted this strategy and what long-term returns and short-term losses you expect from this allocation. You may also want to write down the same information for each individual investment. Then, when market volatility makes you nervous, review your written reasons for investing as you did. That reminder should help keep you focused on the long term.
- Reacquaint yourself with the stock market's past history. While the stock market suffers declines in some periods, over the long term the trend has been upward. Of course, past performance is not a guarantee of future results. Even though short-term setbacks can make even the most knowledgeable investors anxious, take comfort in the fact that staying in the market over the long term, through different market cycles, can help manage the effects of market fluctuations.
- Save more. When markets are fluctuating, you need other strategies to help increase your portfolio's value. One of those is to simply save more of your income. Even modest increases in the amount invested can dramatically affect the ultimate size of your portfolio.
- Invest in a tax-efficient manner. Strategies that defer the payment of taxes can also make a substantial difference in your portfolio's ultimate value. There are several strategies to consider. You can utilize tax-advantaged investment vehicles, such as 401(k) plans and individual retirement accounts. Or you can emphasize investments that generate capital gains rather than ordinary income. You can also minimize turnover in your portfolio, so unrealized capital gains grow for many years.
- Diversify. Spreading your portfolio among a large number of asset and sub-asset classes is a must at all times, but can be particularly beneficial in volatile markets. To the three classic asset classes of stocks, bonds, and cash, you may want to consider adding commodities and real estate. Anyone who added gold to their portfolio 10 years ago has found it to be a good counter to fluctuations in stocks. Also consider investment style, geography, and sectors as a way to further diversify. Consider investing in growth and value stocks, in the U.S. and overseas, and have several sectors represented in your stock portfolio. The key is to find sub-asset classes that are relatively uncorrelated with each other.
- Invest regularly, in all market conditions. Dollar cost averaging is a proven way to put market downturns to your advantage. Investing the same dollar amount every month means that when prices are down, you buy more shares, so that when the markets recover, you get a better return. While dollar cost averaging is a good strategy for developing the habit of regular investing, it does require the discipline to invest consistently. However, it neither guarantees a profit or protects against loss in a prolonged declining market. Because dollar cost averaging involves continuous investment regardless of fluctuating price levels, investors should carefully consider their financial ability to continue investment through periods of low prices.
- Rebalance your portfolio annually. Rebalancing means selling off a portion of the assets that have gained in price and using the proceeds to buy more of the assets in your portfolio that have fallen in price. This technique forces you to realize some of your gains before a downturn takes them away. It also makes you buy more of the assets that lost value at cheaper prices, similar to dollar cost averaging.
- Consider tactical asset allocation. The foundation of any sound investment program is strategic asset allocation: a long-term commitment to maintaining fixed percentages of your portfolio in each of the asset and sub-asset classes you define. But if you expect stocks to decline, you could change to tactical asset allocation. This means that you sell off a percentage of your stock holdings and put the proceeds temporarily into cash. It guarantees you escape some of the damages, though you run the risk of mistiming the market.
In the end, it's important to remain calm during volatile markets, since portfolio decisions made in moments of panic tend not to be good moves. In light of the current market and economic conditions, it pays to review your own portfolio and strategies. Your portfolio should reflect your risk tolerance and investment time horizon. Please call if you'd like to review your portfolio in light of current market conditions.