It is hard not to react to the stock market – especially when it makes wild, unpredictable gyrations up-and-down and steep, unexpected dives.
We look on petrified as our portfolios plunge in value. We call friends, family and financial advisors in search of reassurance. Some of us panic and sell to limit losses. Yet just a few months earlier we were eagerly pouring through news articles and analyst reports looking for the next big thing. A few of us bragged about double-digit returns.
Should we be reacting to the market with such varying degrees of excitement, fear and suspense? Are we being too emotional in our investment decision-making?
Here is some advice on how to respond more constructively to volatile market conditions:
Stock market fluctuations are an inevitable part of investing. Giant swings in the market have happened in the past, and will continue to happen in the future. A common mistake investors make is to let their anxieties and fears get the better of them during tumultuous markets.
“A majority of investors end up buying high and selling low because they panic,” says Carlos Dias Jr., a Registered Financial Consultant (RFC) and fee-only financial advisor at Excel Tax & Wealth Group based in Orlando. “They may re-enter the market later, but what happens when they re-enter is that they have to do so at higher prices.”
Instead, stay calm and assess the situation rationally.
Have a Plan
Before making any investments, an investor should have a financial plan in place. They should know where they are with their finances presently, where they want them to be, and how they intend to get there.
“The investors who came running into my office all in a panic last month, were the ones without a financial plan in place,” says Dias. “As a result, they did not know their risk tolerance, they did not have long-term financial goals, and they had no idea where they wanted to be.”
A financial plan helps investors organize their finances so that they can manage their money more efficiently. For example, what is your cash flow? What is your income each month? Do you have enough money to cover monthly expenses? If so, for how long? How much loss can you realistically tolerate?
Investing is just one component of the overall financial plan. If you do not have a financial plan in place, now is as good a time as any to start one.
Think Long Term, Like 10-Years
One of the best quotes from Warren Buffet says, “If you are not thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes.”
While definitions for long-term vary widely, the general rule here is to assume that long-term assets are not needed in the next three-to-five years, and there is a sufficient cushion of time to allow for markets to go through their normal cycles.
You are not looking at this with a “get in, get out,” or “make a killing” mentality. When you are making an investment, you have to be ready to hold it for a long time, says Dias.
Remember, investing and trading is not the same thing. Trading involves risks and requires financial resources, specialized education and specialized skills. When you are investing, you are looking to build wealth gradually over an extended period of time.
Know What You Can Realistically Stomach
Review your allocations often and make sure your tolerance for loss fits where your assets are currently invested, says Dias. Sadly, many investors overestimate their tolerance, and discover their actual threshold is much lower during a market downturn.
If you are in an aggressive allocation, you have to be able to stomach steep losses and have the resources to weather the storm. If you are close to retirement, this approach may not be right for you. You may need a more conservative approach so that you do not negatively impact your quality of life, cautions Dias.
You have to be realistic, says Dias. Some of us cannot tolerate more than a 15% loss in our portfolios. In situations like that you can set up alerts that will be automatically triggered when that threshold is broken, and you can take appropriate actions.
Practice Discipline & Patience
Developing a long term plan or strategy is in fact the easy part. The hard part is finding the discipline and patience to stick to it because most of us are driven by fear and greed.
For example, in the recent bull market, many investors forgot what happened in the Great Recession of 2008-2009, says Dias. They let themselves be lulled into thinking they can expect average returns of 13% indefinitely. They build their financial plans around that assumption, declining low-risk investments and risk-diversification, to focus on high-risk/high-return investments. “I describe this as the ‘greed’ profile,” says Dias. Investors are human after all. Emotions like greed kick in especially when markets are testing new heights.
This underscores how easy it is to get distracted and lose our focus in times of exuberance, volatility, tumult or uncertainly. To get a handle on volatile markets, we can start by getting a handle on our emotions and ourselves.