Conquer stock market volatility forever
Global stocks fell off a cliff in mid-August and they 've been showing their mean streak since.
Shock and terror are spreading as though the zombie apocalypse has arrived. But why?
Besides the famous certainty of death and taxes, there's another bit of unpleasantness that everyone can count on: The stock market will go down. The silver lining is that it has always gone back up.
"On average, the stock market, as measured by the Standard & Poor's 500 index, experiences four declines of at least 5% every year. The average intra-year decline is 14%," says Andrei Voicu, CFP professional, director of market and portfolio strategy at Coury Investment Advisors in Pittsburgh.
Stock market corrections, downturns or pullbacks should come as no surprise. Even 100-year floods happen every so often. By choosing investments that reflect your needs and risk tolerance, stock market volatility should be reduced to what it really is: mostly noise.
What's your plan?
Having an investment plan in which you are reasonably confident helps allay free-floating anxiety and address questions about what to do in reaction to events over which you have no control.
"That is the easy first thing: Do you have a plan about your investments and overall financial outlook?" says CFP professional Jonathan Duong, CFA, founder and president of Wealth Engineers in Denver.
An investment policy statement can help map out the direction investments should take. It's also useful to have handy when anxiety starts to mount about the economy. You are prepared for contingencies and girded for worst-case scenarios.
These are the questions your investment policy statement will answer:
What is your goal?
Pro tip: Quantify your goal if possible. For instance, I need $3 million when I retire in 30 years. Armed with this data, you can calculate the rate of return needed. That will dictate the level of risk in your portfolio -- or the extra amount you'll need to save to hit that goal if the level of risk is not feasible.
"Without expectations for risk, there cannot be expectations for return," says Duong.
How long will you be investing in the stock market?
Pro tip: "The longer the holding period, the less the probability of losing money. Historically, there were no 20-year holding periods with negative returns," Voicu says.
What is an appropriate asset allocation plan?
Asset allocation is what financial professionals call spreading money around various types of investments, such as large-cap stocks, small-cap stocks and high-quality corporate bonds. It should be based on your goals, time frame and risk tolerance.
Pro tip: Think about worst-case scenarios, such as the recent financial crisis. The S&P 500 lost more than 55% between Oct. 1, 2007, and March 5, 2009. Some portfolios lost more than that and some lost less. Smart asset allocation and diversification can lower the risk in your portfolio and improve returns.
"If the market trends down 5%, find out how far your portfolio has fallen. If you're down an equal amount or more than a major index like the Dow or S&P 500, you may find you're taking more risk than you like," says Robert Laura, president of Synergos Financial Group in Brighton, Michigan.
What is your process for rebalancing or selling investments?
Pro tip: "Maintain a disciplined investment approach. Stay invested and reallocate your portfolio to its intended target allocations if they get out of range. Rebalancing may reduce risk and is an automatic way of buying low and selling high," Voicu says.
If an investment really is a stinker, "take the time to find out if it's a company-specific issue or something across that industry," Laura says.
"Market pullbacks are common and every industry goes through cycles, so it's important to develop a process to both select and sell investments based on what's happening and not just feelings or short-term headlines," he says.
Planning short-circuits panic
There can be unforeseen and expensive consequences to blindly selling in scary market conditions, including transaction costs and opportunity costs. It typically costs money to buy and sell investments. Depending on your holdings, it could cost money to get out and get back into the market.
Selling low also locks in losses.
"Trying to time markets in the short run is counterproductive, as the odds are against you. You have to guess right twice: when to get out and when to get back in. If you don't guess right, long-term returns will be compromised and short-term paper losses may turn into permanent ones," Voicu says.
Employing patience and taking the long view will help you get to the other side of market tumult battered but intact.
"Only the investors who stick with their investment plan harvest the returns from stocks," Duong says. "Jumping out does not lead to success."
In times of duress, use market volatility as a gauge for your risk tolerance. When market conditions return to calm, fine-tune your approach to investing to be better prepared next time.
Don't worry, the market will tank again.