It’s hard to avoid reacting to market turmoil when you’re hit by a tsunami of dire investment warnings and falling prices on all sides. In 2008, the problem was credit risk fears and collapsing home prices – along with $100/barrel oil prices. This time the culprits are different (China economic growth worries, falling oil prices, etc.) but the effect is the same: a nasty market correction.
What should you do? It seems defeatist to say “very little” yet smart investors stick to their investment portfolios and avoid the stampede crowding the exit door. Consider the mistake some investors made when they exited markets in 2008-09. By selling, they locked in steep losses. Often they were too nervous to get back into markets as prices rebounded. The result? A double loss.
In the 2008 crash, a well-known advisor liquidated his client accounts in August 2008 – thereby saving them millions of dollars. This advisor wasn’t shy about how good he felt about his impeccable market timing. A number of years went by and this same advisor was still sitting on cash in his client portfolios! His clients began to complain they were missing out on the bull market rebound and some left him. Perhaps it’s a coincidence, but this advisor has retired from the industry.
Here are some things to keep in mind in the current market turmoil:
1. Market timing doesn’t work:
Stocks have outperformed other asset classes since tracking began – including bouts of steep declines. Investing in stocks means remaining disciplined through both good times and bad. There is no formula for consistently timing markets to buy at the bottom and sell at the top. Investors who attempt this end up with sub-par performance because they often ends up doing the opposite: buying “high” and selling “low.”
2. Free Lunches are a myth:
Higher historic returns on stocks go hand in hand with higher volatility. By comparison, we expect a lower return from bonds in exchange for lower volatility. Pursuing higher long-term returns means accepting accompanying volatility. There is no free lunch in markets.
My clients have portfolios that are based upon their unique financial and personal circumstances. Our view on this doesn’t change if stocks correct by 10% or rise by 10%. We periodically rebalance but we don’t panic buy or sell. If fundamentals are little changed, lower stock prices – if anything – make stocks more attractive. Taking a long view on investing helps avoid short-term over reaction.
3. Diversification remains key:
Diversification is the one free lunch in the investment world. The magical effects of diversification – which help smooth returns over time – persist. During a massive sell-off, stocks, bonds, commodities, real estate and other asset classes may all exhibit weakness but this is a short term phenomenon. Once excessive panic selling is behind us, the benefits of diversification again become obvious.
4. Avoid having an emotional reaction to your investments:
Your core portfolio should be sufficiently diversified (multiple assets classes with lower correlations) to give you the highest probability of achieving your goals for the reasons that are important to you. Stick to your core portfolio and look to rebalance so your portfolio remains on track.