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The first four trading days of 2016 were the worst to start a year in the history of the S&P 500, and volatility continues to take investors on a roller-coaster ride as February begins. In the face of that kind of downward pressure, and the ensuing onslaught of negativity in the media, it can be extremely difficult for investors to keep a level head.
The bad investor behavior that tends to derail long-term portfolio success is hard to avoid in times like these. Here are a few strategies to help you maintain your investing resolve during tough times.
1. Have a plan
The benefits of a solid financial plan cannot be overstated. By focusing on your short- and long-term goals and creating an investment strategy designed to address those specific issues, you greatly increase the chances of staying on target during times of heightened volatility. Studies show that clients with a financial plan are much better prepared for the important financial milestones that concern most of them, which significantly increases their odds for success. For example, according to HSBC retirement studies, people with financial plans had nearly two-and-a-half times more in retirement savings that those with no plan. Have a plan and stick to it.
2. Diversify your investments
It’s amazing how often clients show us a portfolio consisting almost entirely of stock from their companies, without any sense of how precarious this situation can be. Their income, benefits, investment portfolio, and even retirement account balances all depend on the health of their employers. In essence, their entire financial life is tied to that one company, and regardless of how great the widget they make might be, it can backfire. Just ask the former executives of once-great companies such as Enron or Lehman Brothers.
The adage “Don’t have all of your eggs in one basket” is as old as investing itself, but it’s not always easy to keep top of mind. The outperformance of U.S. stocks over many other asset classes during the bull market of the past five or six years caused many to question the effectiveness of a diversified portfolio strategy. I recall a client who asked whether we should divest completely from bonds because of the likelihood of a Federal Reserve rate increase and what he had read would lead to an inevitable steep drop in bond prices. As of Jan. 26, the S&P 500 was down over 6%, and the Barclays U.S. Aggregate Bond Index was up about 0.9% for the year. The arguments for discarding time-tested, long-term strategies over worries about short-term changes tend to falter over time.
3. Don’t try to time the markets
If the Great Recession taught us anything, it’s that markets tend to rebound when you least expect, and they tend to do it quickly. In March 2009, the S&P 500 was at 676, and no one seemed to know just how low it might go. By September 2009, just six months later, the S&P 500 stood at 1,025, an increase of over 50%. Staying invested in the face of downward momentum may take a strong stomach, but bailing out with the idea that you’ll jump back in once the market turns is a recipe for disaster. First, by getting out while the market is falling, you turn paper losses into real losses. Second, because picking the actual bottom is extremely difficult, you’re likely to suffer the double-whammy of missing out on the best of the rebound as well.
4. Turn volatility into opportunity
It never feels good to see the value of your investment portfolio dropping, but this kind of volatility can actually be a good thing for many investors. Let’s say you go to Macy’s and see a jacket you love that costs $100. The next week, you see the same jacket on sale for $75. Great, it’s time to pull the trigger, right? No, instead you decide to wait until the price goes up to $150. This makes no sense, but millions of investors do something similar. When the market is up, they feel great about it and can’t wait to commit more money to it. When the bear market hits, they get spooked and tend to want to wait it out until things look better.
By understanding that volatility is natural and treating it as an opportunity, adding capital to your portfolio during times of downward pressure, you’ll likely be rewarded over the long term. Better yet, if you continually and systematically contribute, you can weather market volatility by buying fewer shares when the market is high and more shares when it is low. This strategy helps take emotion and guesswork out of the investing equation.
5. Stay focused on your goals
By focusing on your goals, it’s easier to block out short-term noise and concentrate on what you’re trying to achieve over the long run. This isn’t easy, particularly when the media seem full of negative news.
Negativity bias causes people to instinctively focus more on bad news, rather than good. This makes sense from an evolutionary standpoint: If you’re trekking through the woods, this instinct can help keep you alive. But in investing, this instinct can cause you to potentially overestimate the risk you may be exposed to, which in turn can lead to emotional rather than rational decisions. By staying focused on your goals and the strategies designed to help achieve them, it’s easier to accept volatility.
Maintaining a long-term outlook and keeping your emotions in check during wild market swings takes a strong stomach, and for many, help from a professional. But if you can avoid falling into the same behavioral traps that have plagued so many investors for so long, the rewards likely will be significant.
Image via iStock.