The term “unprecedented” has often been used to describe many things we’ve experienced over the last few years and was even named 2020 Word of the Year, but it shouldn’t be used to describe volatility in the stock market. While unpleasant at times, ups and downs in the stock market are a normal part of investing and shouldn’t come as a complete surprise.
Volatility can be unsettling for many investors and might naturally be stressful for some. What should investors do when stock prices become volatile? Should they try to predict the next market move when newspaper headlines call for a downturn?
Let’s first take a step back and examine why we invest in the first place. Then we can better answer these questions about how to approach volatility.
What is the purpose of investing? It is likely something we’re doing to help us achieve a goal. Whether it is saving for retirement, providing for a family, giving to charity, or passing on wealth to a future generation, most goals typically involve spending wealth in the future.
The cost of achieving these future goals and the goods and services we spend our money on usually increase over time. Right now, we’re feeling the impact of this inflation more than we have in decades. Whether it’s the grocery bill, the price of filling your car up with gas, or buying a new car – the price of everything is rising. This inflation of prices erodes the value of what we’re able to do with our money.
If you have cash just sitting in a bank account and not invested, you should expect the real value of your money to decrease. We must address this risk of inflation and invest our cash so it can also grow over time.
The good news is the stock market has historically outpaced inflation over the long term. Going all the way back to 1926, the annualized inflation-adjusted return on the S&P 500 is 7.3%. This is one important reason why it is important to invest – and stay invested in your target asset allocation. If you sell your allocation to stocks and bail from your investment plan this creates a new risk – the risk of not having enough money to achieve your defined goals.
Investing is important but it also must be done with the right approach, a plan, and discipline to stick with your plan.
How can we approach market volatility?
When the market is going up it’s easy to stick with your plan. What sets an investor apart is the action they take or don’t take when volatility strikes.
What paths can an investor take?
1) Attempt to time the market by trying to predict future movements to buy stocks low and sell high.
2) Consistently invest in a portfolio with a mix of stocks and bonds designed to account for future market ups and downs.
In my prior role as a Regional Director at a large investment manager, Dimensional Fund Advisors, I spent time meeting with hundreds of financial advisors across the country. During this time, I was able to personally see the different experiences investors faced when going down these two competing paths. The investment community has also done extensive research on comparing the financial results of these different ways to invest.
The evidence is compelling that investors who attempt to time the market by betting on predictions of future movements are generally unsuccessful over the long term.
While that could be disappointing – there is good news! You don’t have to try to time the market to have a successful investment experience.
Proactive or Reactive?
If an investor attempts to get in and out of the stock market based on reactions to news their guess must be correct not once, but twice. They must be able to accurately determine when to get out of the market and also when to get back in. In addition, the stress of being in the market can quickly be replaced by the stress of being out of the market – fear of missing out on rising stock prices.
Another approach is to work with a financial advisor to design a plan that accounts for anticipated volatility in markets before it occurs. This plan is developed by combining a mix of growth assets (stocks) and assets to reduce volatility (bonds) that is specific to an investor’s personal financial situation and goals. While we don’t know when or where the volatility will appear when you plan ahead it allows you to be proactive instead of reactive. Taking this approach and knowing you have an investment plan you have confidence in allows you to not only have a favorable investment experience but also a greater sense of security knowing that you’re proactively addressing these risks.
Focus on What You Can Control
Experiencing volatility in the stock market can be stressful but making investment decisions based on a rollercoaster of emotions is not the solution. Take proactive control to have a plan in place so when the market dips you are confident that your investment allocation was designed to account for the inevitable market swings.
It is our goal to not only help clients have a positive investment experience but also that they have peace of mind knowing they are already addressing risks.
If you or someone you know has not yet worked with us to design your personal investment plan, please contact one of our financial advisors in Austin. We’d love to meet with you and discuss how we can help make sure your plan is in place.