At a mere three weeks into the New Year, the stock market has dropped more than 10% and this has many investors questioning the state of the economy and looking for ways to quell the free fall of their investment accounts.
If nothing else, the beginning of 2016 has served as a reminder that market volatility is inevitable. And although this shouldnt come as a surprise, the emotional roller coaster of market fluctuations can cause even the most disciplined investors to occasionally veer off course.
If youve turned on any financial program over the past few weeks, you have undoubtedly heard some pundit discussing how you should just stay the course because the market always rebounds.
But what does that really mean when youre watching your retirement account go to crap? As well meaning as these financial professionals may be, there cant be a one-size-fits-all approach to investing — and thats exactly what advice like stay the course is.
As the Market Tanks – Have a Plan
I am in no way attempting to insult your intelligence by stating the obvious here; but theres a reason that its called financial (or retirement) planning. The planning piece is arguably the most important part of the equation.
Developing a financial plan forces you to consider things like income, expenses, long-term goals, and risk tolerance to determine what path you should take toward your version of financial success — regardless of what the market does.
In fact, depending on the parameters of your plan, there may be nothing wrong with sticking to your guns when it seems that the sky is falling around you.
The problem is, few investors have the discipline to curb their emotional response to the ups and downs of the market — and many end up pulling their money out when the market is down.
As many financial professionals will tell you, you dont actually lock in your losses until you pull your money out. Of course, thats the worst possible time to act because, not only do you solidify your losses, but you eliminate any opportunity to participate when the market finally rebounds.
The other day in passing, I heard something from Joe Mansueto, CEO and majority owner of Morningstar that provided a perfect description of the investing mindset necessary to win by staying the course. To paraphrase: an investor should think like a business owner, not a renter. Businesspeople dont wake up every day and ask whether or not they should sell their business that day.
Instead, they show patience and persistence in their current circumstance, and try to understand their underlying business better so they can earn the greatest return for the longest period of time.
The same could be said for investors that have set out on particular path toward achieving their financial goals.
Essentially, stay the course – even as the market tanks.
On the surface this seems simple enough, just stay in the market right? Well, not exactly! For example, maybe Im a few years out from retirement, extremely risk averse and just cant stomach more than a 5% loss in the value of my portfolio. Should I just stick it out as the market continues to fall?
But again, it goes back to having a plan and more importantly a process to manage the volatility in your portfolio.
Similar to the way that you shouldnt just buy an umbrella after youre already drenched, trying to plan for the ups and downs of the market in the middle of intense fluctuations is also counterproductive. It’s during good times that you should start preparing for the rougher times.
Now, this doesn’t mean that your plan necessarily has to change. But you should have a process in place that causes you to periodically revisit your goals and stress-test your portfolio to ensure that youre still on track.
As the Market Tanks – Revisit Often (and pivot if necessary)
Over time some of your investments may perform better than others. This could potentially put you at risk for having a disproportionate number of holdings in a particular industry than you originally planned. In order to stay true to your investment plan, it is imperative that you revisit your accounts often and reallocate your money based upon the structure of your original strategy.
Recent experience shows us that sticking with a plan is challenging, especially when the market is doing well. Take the period just before the most recent financial crisis as an example.
In the run-up leading to debacle of 2008, a prudent investor would have scaled back in anticipation for an inevitable dip in the market. However, many didnt and although it was virtually impossible to remain unscathed during this time, by not staying true to the parameters of their financial plan, many investors took more of a loss than necessary.
While nearly all portfolios have bounced back, Id be willing to bet if you interviewed investors that lost a significant portion of their net worth, if the potential upside gain was worth the risk, I doubt that you would have many (if at all) that would agree.
Thats why it is important to revisit your plan often and make adjustments as needed. Its easy to view your statement, see double-digit returns and think that you can just ride the wave. But thats not always what coincides with your long-term financial strategy.
So, how can you as an investor handle the market uncertainty? Simple: Stay on YOUR course and dont let emotion throw you off track!
This post was written by Kelby from TheFrugalennial.com
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.