Are Volatile Stock Markets Good for Investors?
- May 5, 2020
- By: Marcos Segrera, CFP®
When the ups and downs of stock markets leave you stressed and wondering whether stocks really will help you pursue your long-term financial goals, there are two things to remember:
1. Historically, over long periods, stocks have tended to move higher.
For instance, at the start of October 1987, the Standard & Poor’s (S&P) 500 Index was valued at 327. On Black Monday, October 19, 1987 the Index lost 22 percent in a single day. By the end of the month, it was trading at 247. Here’s what that looked like:
That’s a precipitous drop. Many investors wondered if their portfolios would ever recover.
By June of 1989, the SP was back at 327 and the drop in October of 1987 looked like an obvious buying opportunity.
Jumping ahead, in October of 2007, the SP reached its top of 1,565 before falling to its bottom of 676 on March 9, 2009. This was the Great Recession; an incredibly scary time to be an investor. It took the SP until April of 2013 to get back to its previous high of 1,565. At the end of 2013, the SP would close at 1,848. Here’s what that looked like:
In hindsight, the Great Recession, too, looked like an obvious buying opportunity.
We could review examples like this all day, but the point of this brief history of market downturns is that markets are volatile. They suffer losses and experience gains. However, over time, they have trended higher. This volatility/uncertainty is the reason why investors in stocks have been able to average a historical return of 10 percent per year.
When it comes to investing, we can’t know exactly how or when things are going to turn out all right. But with history as our guide, we can have faith that things will turn out all right. As investment advisors, we try to coach our clients not simply to accept volatility but to embrace it – after all, that’s where the premium returns you enjoy so much as a stock investor are coming from (it’s why bond returns are half of stock returns).
All successful investing is a battle between our need for certainty and our tolerance of ambiguity. The emotional capacity to function under uncertainty is both the key to capturing stock market returns and a critical test of emotional maturity. The more certainty you need, the more you’ll allocate your portfolio toward bonds and the lower your returns will be. Successful investing isn’t intellectual; it’s emotional/behavioral. Keep this in mind when building your plan with your advisor.
1. Market volatility may create opportunities.
When a portfolio loses value in uncertain markets, it’s natural to wonder whether you should sell. And sometimes investors sell without considering how it will affect their long-term goals. While selling isn’t always a mistake – perhaps your asset allocation is out of balance or you want to harvest tax losses – selling without a strategy may be erroneous. As we tell our clients, panic (and euphoria) are not investment strategies. Most unsuccessful investing is caused by reacting to whatever markets happen to be doing at the moment. We believe that successful investing involves constantly acting toward the realization of your goals. The fact that the markets aren’t doing what you want them to do when you want them to isn’t an indictment of the markets.
Keep in mind that over the last 40 years of SP 500 history, it has fallen, on average, by 14 percent each year. Of those 40 total years, 30 of them ended with positive performance.
The reality is that volatility is normal. However, in our experience, the only way to take advantage of these moments is to have a plan. A portfolio alone is not a plan. A portfolio is a tool that will help you achieve the specific components of your plan. Having a plan in place gives you the opportunity to see corrections and bear markets as equivalent to a big sale.
Here are a few tips that can help you avoid mistakes and make the most of opportunities during periods of market volatility:
· Keep perspective. As the examples above demonstrate, stock market downturns are normal. Historically, markets have recovered and delivered positive returns over the longer term.
· Stay the course. Our natural instinct for self-preservation leads some investors to sell when markets drop. This locks in losses. Exercise patience and discipline. Investing is not the game where the person with the 120 IQ beats the person with the 100 IQ. Temperament is the difference.
· Review your asset allocation. If you haven’t done so recently, review your asset allocation strategy. Does it still match your target allocation? Do you know why this is your target allocation? Sometimes, particularly after periods of substantial market volatility, a portfolio needs to be rebalanced.
· Buy low. During periods of market fluctuation, you and/or your advisor may find opportunities to buy stocks at attractive prices. By investing in well-priced, diversified opportunities, you position yourself for strong performance. By definition, rebalancing accomplishes this.
· Review your risk tolerance. If market volatility is causing you to lose sleep, it’s possible that your risk tolerance has changed or is lower than you anticipated. If that’s the case, it may be wise to reduce your overall portfolio risk. Talk with your advisor before making any changes.
· Harvest tax losses. Talk with your financial advisor and tax professional about whether you could benefit by selling investments during a downturn and taking the losses for tax purposes.
· Consider a Roth conversion. If you’ve been thinking about converting a Traditional IRA into a Roth IRA, completing the move during a market downturn could reduce the amount of taxes owed. This strategy is best executed with the help of your advisor and your CPA.
Whether you’re investing to meet short- or long-term financial goals, it’s important to recognize the opportunities created by market volatility and to work with your advisor to make the most of them.
Happy investing and stay safe.