Strategies to deal with market volatility
Last week, I wrote about the 5 realities of the stock market. From these points, it is easy to see that short term irrational behavior can be the biggest mistake made by any investor. This week the markets continue to jump around so I thought is would be appropriate to share my thoughts on investment strategies to deal with market volatility.
Use logic over emotion.
Is investing emotional or logical? When markets are at the point of maximum risk, investors’ emotions are characterized as optimism, excitement and euphoria. On the other hand, when markets are at lows, rather than logically seeing a buying opportunity, investors feel negative emotions like fear, panic and depression.
Logically, successful investing is actually quite simple. Keep emotions out of the picture because it is emotions that prevent you from doing the proper things at the right time.
You have heard professionals tout the merits of long term investing. Sometimes investors, especially older ones, feel like they have less time to invest. When markets are down, their nervousness is magnified. Sometimes it has less to do with time and more to do with patience. You can have time and not patience. Some people have a lot more time than they think. Consider that even at age 65, there is a still a potential time frame of over 10 to 15 years.
Market movements are random in the short term. However, over time markets are actually quite predictable. They go up. The more patience you employ, the greater the probability of a positive return.
From 1987 to 2011, if you look at any rolling 12-month period in the markets (TSX), you will find periods of negativity 27.34% of the time. However, if you look at any five-year period, there has only been 5 negative periods out of 241 (2.1%). On a rolling 10 year basis, there has been no periods of negativity. The worst 10 year period was August 2000 to August 2010 with a 2.84% compound average annual return. Patience is one of the key principles of investing.
As much as patience is important, market volatility usually hits retirees the hardest. When retirees are taking income from a portfolio, the math can really work against them. It’s important for retirees to be more conservative.
The rule to investing is simple – buy low, sell high. When markets are down, fight the fear and invest. In everyday life we look for bargains and everybody loves buying things on sale.
The only exception to this rule is what we see when it comes to investing. Nick Murray, author of “Simple Wealth, Inevitable Wealth” says it best, “Investors always do the wrong things at the wrong time – they buy when they should sell and they sell when they should buy.”
When markets are down and times are tough, you may be amidst tremendous buying opportunities. Fight the emotion to sell in a bear market and buy when markets are on sale.
Do not try to time the markets
Market timing implies that one can predict the future with some degree of accuracy. The reality is I have not met anyone with this incredible gift. No one can foresee the future. No one is able to achieve perfect timing consistently.
Do not chase performance
Unfortunately investing is not as easy as picking last years winners! Wouldn’t it be nice if last year’s best performing investments continued to be this year’s best performing investment? The reality is that hot investments can cool down very quickly and cold investments can become hot. Chasing performance is one of the most common strategies for investors, yet research shows it does not work!
Invest in a well-constructed portfolio
Believe it or not, there is a science to investing. George Hartman, author of Risk is a Four Letter Word says, “Investing is an inexact science. It is better to be approximately right than precisely wrong.”
The science of building a diversified portfolio can be compared to baking a cake. You must take different ingredients in the proper proportion and mix them together to accomplish the end result. Baking a cake is not just a matter of mixing different ingredients in any proportion. You not only need the right ingredients but you also the right amounts. Too much of one ingredient can ruin the cake.
With investing, you must properly mix ingredients. This science is called asset allocation.
Markets are fun when they go up and not so fun when they come down. Investing is much tougher emotionally when markets are down so hopefully these strategies help you deal with periods of market volatility.