“The intelligent investor is a realist who sells to optimists and buys from pessimists.” Benjamin Graham
“The stock market is a device to transfer money from the impatient to the patient.” Warren Buffett
The financial markets are always in flux.
Investors tend to dislike turbulence but need to understand that it happens. Periods of calm alternate with volatility. Turbulence is a force of nature of the stock markets to be reckoned with. Often, that is the best time to buy stocks of good companies.
Markets regularly adjust to changes in economic fundamentals, business cycles and current valuation levels. Stock prices are influenced by interest rates, sensitive to economic growth and steered by company earnings.
Higher levels of noise can impact the financial news cycles, adding more angst for the average investor.
Market Volatility Should Be Expected
There have been 11 historic bear markets (declines of 20% or more from their high) since the Great Depression (October 1929-June 1932). That was among the longest and most severe, reflecting an 86% decline from the high to the low S&P 500 prices in 34 months.
In comparison, the bear market caused by the Great Recession lasted from late 2007 to March 2009, causing a pullback of 56%.
Those were particularly painful declines, causing many investors to lose money as they sold their shares out of fear. Had they held on to their shares, or bought more at the trough, they would have seen the market rise 68% by March 2010.
Who can forget the tantrums the market threw after the Powell-led Fed raised the fed funds rate by a quarter of a point in mid December 2018. This caused the Dow to lose over 1,800 points within the following four trading sessions in a volatile year. Stocks have recovered in 2019 year-to-date.
Related post: 11 Reasons Why Investors Need To Understand The Fed
Corrections are more common, less severe and shorter than bear markets. They occur about every 15-17 months with price declines of 10% from their high. While we can’t control when markets fall into bear territory or corrections, we can better prepare for them with a financial plan.
A Good Financial Plan Helps To Navigate Volatility Better
Having a financial plan that helps you meet your financial goals for the long term is important. Investing for the long term does not mean you don’t make changes in the short term to address market movements. You may also want to speak to a financial planner about your risk tolerance and plans for the future.
1. Put Your Financial Life In Order
Before investing, make sure you have savings that can pay for your basic needs now and for any unforeseen circumstances. Create an ample emergency fund that is liquid and can take care of six months of monthly fixed costs such as rent or mortgage, food, and car payments, and along with unplanned financial costs.
Take advantage of your employer’s 401 K retirement plan, if offered, by contributing the maximum amount from your paycheck to their match. By saving for retirement, you are beginning the process of investing for your future.
As you accumulate assets, you want to allocate your portfolio among different classes and different types of accounts. You want to spread risk into different but complementary baskets such as stocks, money markets bonds, and real estate.
Invest some of your money in cash-equivalent securities like money markets and Treasuries. While they will generate lower returns, they will be a comfort in times of market volatility.
Diversification of your portfolio is important whether on your own through outright stock purchases, by buying low-cost index funds, or in consultation with a financial advisor.
Related Post: 10 Tips To Diversify Your Portfolio
3. Asset Allocation
You should target different allocations based on your age and retirement plans.
Usually, the younger you are, the greater the risk tolerance you have. You will invest differently when you are in your 20s and have a longer time horizon. Compounding your investment returns can enhance your wealth substantially.
In your 60s, preservation of capital is more of a priority because retirement is approaching. Review your investing and rebalancing strategies periodically to make sure your holdings reflect your goals.
Set up different investing accounts depending on its purpose, notably for retirement, 529 savings plan, and insurance.
4. Don’t Sell Your Stocks Out Of Panic
We get very emotional when we lose money in the stock market. I know I have gotten anxious when my stocks are declining for days or weeks on end. Funny how we don’t react that way when our stocks soar in our portfolio.
It is not unusual to feel dread at prolonged declines in the market. The market can be a very humbling place to be in. Sometimes stocks decline on no new news yet the drops feel like they are on automatic pilot. The financial news headlines sound like the opposite of what you read the day before.
Remember that you haven’t lost a penny until you sell your stocks. The stocks are only declining on paper. If you sell your stocks based on fear, you may be making a premature exit. In the past, I have sold some positions in choppy markets only to find it difficult to buy them back when the market recovered.
It helps to remember your long term investing perspective. Weakness in the market is part of the short term adjustments that occur regularly albeit unpredictably.
5. Keep Emotions In Check
Don’t act irrationally. If you have food on the table, a roof over your head, you and your loved ones are healthy, things are good.
“A lot of people with high IQs are terrible investors because they’ve got terrible temperaments. You need to keep raw, irrational emotion under control.” Charlie Munger
Biases Cause Us To Make Mistakes
Avoid “action bias.” Behavioral scientists use that term to describe why we sell our stocks when markets go down. We feel we need to do something when we get anxious. Sometimes we sell our risky assets for reduced amounts of cash.
Sometimes we sell our winning stocks that have some gains in them. This is known as “disposition effect.” This is often a mistake because these stocks may have better long term potential and you may end with a portfolio that has more losers than previously.
Availability bias is a cognitive bias that may cause people to incorrectly assess the likelihood of events by remembering past events. For example, the correction in the market may remind us of what we experienced during the financial crisis. We recall how stocks dropped more than 50% during a once-in-a-lifetime event and sell our positions to avoid repeating those losses.
Another mistake commonly made is when we don’t want to sell a stock because it is below the price we paid. So we hope it will get to that price and sell it then. This called “anchoring.”
We need to look at the stock at its current price and decide if we still like it for its fundamentals, rather than what our cost is. The company may have stumbled and a new management is promising. Keeping the stock makes sense. However, if the company’s fundamentals have deteriorated or if it is restating past financial statements, we may need to sell this position even if it is below our cost.
Another bias when invested in the market is overconfidence. Studies show that 75% of us see ourselves as above average, which is mathematically impossible. Therefore, overconfidence is especially a dangerous bias to have in financial markets because we can overestimate our knowledge and abilities while underestimating risks.
6. Don’t Time The Market
You always hear the adages: “As January Goes, So Goes the Year,” “Sell in May and Go Away,” “Buy Low” and “Sell High,” but no one can truly time the market. No one can predict the beginning of a recovery with precision or sell on the perfect day before the start of correction.
If you must invest according to a saying, then use one of my favorite’s of Warren Buffett’s: “Be fearful when others are greedy and greedy when others are fearful.”
Buffett’s wisdom is contrarian and means that when stock prices rise and markets get overbought, it is time to exercise caution. On the other hand, when stock prices decline and the market is oversold, it is time to look for bargains. Don’t buy as markets climb.
Jumping in and out of the market is fraught with costly mistakes for average investor, besides the commission payments. Good investors maintain their stock exposure while making adjustments to their holdings and allocation.
7. Be Patient As Investors
Most investors lack patience, especially younger investors. A Schroders global investor study found that investors tend toward short-term investing, expecting to hold their investments three years on average. However, investors ages 18-35 desire a minimum return over 10.2% but expect to hold investments for just 1.5 years. This is unrealistic.
Over the longer term, stock investors have enjoyed annual returns of around 10% based on S&P 500 prices over 80 years. However, investors rode out “boom and bust” cycles during that time .
It is no wonder the best investors like Warren Buffett practice “Buy-Hold” strategies for their investment portfolio and outperform the market.
Tolstoy said, “The two most powerful warriors are patience and time.”
8. Use Disciplined Approaches
Pruning Your Winners
Long term investors often prune their positions that have become outsized in their portfolios. Investors should practice good discipline. Consider selling part of your position when you have reached a gain of 20-25% over your purchase price.
Knowing when to take profits is always tricky. As a subscriber to Investor Business Daily and their products, I have benefited from exercising their prescribed discipline. A wise Wall Street adage says, “Bulls make money, bears make money, pigs get slaughtered” reminds us not to get to greedy about our profits.
When buying a new position for your portfolio, buy your targeted stock in parts. For example, if you are expecting to buy a $20,000 (or $100,000) position of a stock, start with 25% of your position, and use your cash to buy the dips over time to bring the average cost of the position down, if you still believe strongly in the merits of the holding.
There will usually be opportunities to buy at a lower price. If it doesn’t come, you probably have a high quality problem with a potentially winning stock.
9. Meeting With A Financial Professional
As individuals, our risk thresholds differ based on our lifestyle, age and future plans. Investing is a wonderful way to grow your wealth. Building your goal-oriented personal approach requires diligence, knowledge, and perseverance. You need to understand investment risk, allocation, diversification, and how to make rational financial decisions.
It is prudent to meet with a financial professional to help you proactively plan and implement strategies to achieve your financial goals. These strategies can broaden to tax planning, estate planning and family wealth.
It is also helpful to have a sounding board when you feel concerned about market turbulence. They can talk you down from the sometimes emotional roller coast that accompanies being an investor. Depending on your financial professional, they can provide their own wealth of knowledge and experience and that of the team they may be working with.
10. Your Financial Plan Is Your Long Term Road Map
It probably goes without saying, that you need to be diligent about your assets, their returns and your comfort level with your financial professional, if you have one. Do your own research. There are a lot of resources to educate you about your investments, read company releases and financial documents, listen to or read company transcripts from investor meetings or earning calls.
Do your holdings fit with your current lifestyle. Review your plan for potential life changes like marriage, children, divorce, college, second careers, and retirement.
There are many trade-offs you and your family may need to make. A good financial plan should be reviewed throughout your life. There is an indelible scene from Alice in Wonderful by Lewis Carroll that resonates with investors and financial planners alike.
Alice is at a fork in the road. “Which road do I take?” She asked.
“Where do you want to go? responded the Cheshire Cat.
“I don’t know,” Alice answered.
“Then, it doesn’t matter” said the Cat.
With a sound investment strategy and a good financial plan, you can build your wealth for the long term.
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With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.