Staying the course
Use this checklist to help guide you through turbulent markets.
Given what we know about how market volatility can transform a calm, cool and collected investor into an emotional, panicked and scattered one, having a checklist to consult during the next period of instability might mean the difference between reaching your goals and falling short of them.
The next time volatility strikes, consider taking these 6 steps:
1. Take your emotional temperature.
We shouldn’t be surprised that when markets decline our moods tend to do the same. Yet even if we acknowledge that market declines are a reality, we are still susceptible to letting the emotions that accompany those downturns drive decisions at odds with key investing goals.
According to behavioral economist Dan Ariely in his book, Predictably Irrational, it’s important to understand the surprising power that emotions can exert over our choices. “Although there is nothing much we can do to get our Dr. Jekyll to fully appreciate the strength of our Mr. Hyde, perhaps just being aware that we are prone to making the wrong decisions when gripped by intense emotion may help us.”
2. Turn down the volume.
In an age of nonstop connectivity, tuning out financial news can be tough, but fixating on daily or even weekly market returns can spur us to actions that might ultimately impede our long-term success.
One strategy for curbing the emotional impact of market volatility is to review the value of your investments only at regularly scheduled times. Many investors elect to do so quarterly upon receiving account or brokerage statements. This diminishes the likelihood that they will feel it necessary to make constant changes in response to day-to-day market swings.
3. Find the broader context.
Ask the average investor how many 20% market declines they’d expect to experience over a 25-year period and chances are the answer will fall short of the number suggested by history. The figure, based on the unmanaged Dow Jones Industrial Average dating back to 1900, is about 7. That’s right, roughly once every 3 ½ years (assuming 50% recovery of lost value between declines), the Dow has lost at least 1/5 of its value.
Having that historical perspective can strengthen your resolve to stay invested, which can be a key to long-term success. After all, pulling out of the market at a high point and buying back in at the bottom is almost impossible to do once, let alone more than a half dozen times during your life as an investor.
4. Recognize the potential harm of sudden movements.
A recent survey by financial research firm Dalbar determined that over the 20 years ended December 31, 2009, the average stock investor’s return trailed that of the broader market as measured by the S&P 500 index by nearly 5% per year. Put another way, if the market gained 10% annually, the average investor’s portfolio realized only a 5% yearly gain.
Much of this differential stems from investors who sold near the bottom of the market and missed some of the market’s best days while sitting on the sidelines. Market turnarounds often happen suddenly and unpredictably; being on the sidelines when a reversal occurs can rob investors of significant return potential over longer periods.
5. Think like a contrarian.
Though continuing to invest when markets are declining can be difficult, if you believe that stock and bond funds are a good way of meeting long-term financial objectives — which has been the case historically — then making purchases during a downturn is often like buying investments at prices below their long-term average. That’s because as markets become less emotionally driven, stocks and bonds generally return to something closer to their long-term average, and investors who “bought on the dip” can benefit.
While regular investing doesn’t ensure you’ll make money, staying the course through thick and thin can help increase your share balance, which can increase your portfolio’s ability to provide income.
6. Check in with your financial adviser.
No one would set out on a Himalayan trek without enlisting a guide who knew how to navigate the most perilous stretches. So it goes with investing.
Your financial adviser can be a steadying presence when market conditions get tough. Maintaining open lines of communication can prevent you from taking steps that could undermine your long-term goals.
Go to Understanding risk and volatility to learn more about the value a long-term perspective