Six Strategies for Volatile Markets
The markets have become volatile once again, as concerns about China's economy add to fears of a global economic slowdown. Add to that volatility in oil prices, changes in the relative strength of currencies, and expectations that the U.S. Federal Reserve will gradually raise interest rates, and the result is uncertainty in the markets.
“Nothing causes investors to question their strategy and worry about their money like a dramatic sell-off,” says John Sweeney, Fidelity executive vice -president of retirement income and investment strategies. “A natural reaction to that fear might be to reduce or eliminate any exposure to stocks, thinking it will stem further losses and calm your fears, but that may not make sense in the long run.”
In fact, what seemed like some of the worst times to get into the market turned out to be the best times? The best five-year return in the U.S. stock market began in May 1932-in the midst of the Great Depression. The next best five-year period began in July 1982 amid an economy in the midst of one of the worst recessions in the post-war period, featuring double-digit levels of unemployment and interest rates.
It has paid to stay investing in U.S. stocks during troubled times.
U.S. stock market returns represented by total return of S&P 5000® Index. Past performance is no guarantee of futureresults. It is not possible to invest in an index. First three dates determined by best five-year market return subsequent to themonth shown. Sources: Ibbotson, Factset, FMRCo, Asset Allocation Research Team as of March 31, 2015.
What does this mean? It may not be prudent to bail out of the market when it is volatile. What is appropriate: Be prepared.
“Market volatility should be a reminder for you to review your investments regularly and make sure you have an investment strategy with exposure to different areas of the markets—U.S. small and large caps, international stocks, investment grade bonds—to help match the overall risk in your portfolio to your personality and goals,” says Sweeney.
1. Have a strategy.
Your time horizon, goals, and tolerance for risk are key factors in helping to ensure you have an investment strategy that works for you. Your time horizon is the amount of time you can keep your money invested. Your tolerance for risk should take into account your broader financial situation such as your savings, income, and debt—and how you feel about it all. Looking at the whole picture can help you determine if your strategy should be aggressive, conservative, or somewhere in between.
2. Be comfortable with your investments.
If you are nervous when the market goes down, you may not be in the right investments. Even if your time horizon is long enough to warrant an aggressive portfolio, you have to be comfortable with the short-term ups and downs you'll encounter. If watching your balances fluctuate is too nerve-racking for you, think about re-evaluating your investment mix to find one that feels right. But be wary of being too conservative especially if you have a long time horizon because more conservative strategies may not provide the growth potential you need to achieve your goals. Set realistic expectations, too. That way it may be easier to stick with your long-term investment strategy.
Choose the asset mix you are comfortable with.
Data Source: Ibbotson Associates, 2015 (1926-2014). Past performance is no guarantee of future results. Returns include the reinvestment of dividends and other earnings. This chart is for illustrative purposes only. It is not possible to invest directly in an index. For information on the indexes used to construct this table, see footnote 1.
One of the most important things you can do to help manage the risk of volatile markets is to diversify. While it won't guarantee you won't have losses, it can help limit them. It was put to the test during the extreme market volatility in 2008.
Look at the performance of three hypothetical portfolios: a diversified portfolio of 70% stocks, 25% bonds, and 5% short-term investments; a 100% stock portfolio; and an all-cash portfolio (see chart below).
By the end of February 2009, both the all-stock and diversified portfolios would have declined. But diversification would have helped reduce losses compared with the all-stock portfolio. Now look at what happened when the market recovered. Our hypothetical all stock portfolio would have risen the most, followed by the diversified portfolio, and then all cash. This is a good example of how such portfolios can behave in rising markets. If the market continues its upward trend, the diversified portfolio might gain less than the all-stock portfolio but more than the all-cash portfolio. Diversification can help to manage the risk level of the portfolio.
Diversification has helped to smooth out market volatility.
Source: Strategic Advisers, Inc. Hypothetical value of assets held in untaxed accounts in all cash portfolio; a diversified growth portfolio of 49% U.S. stocks, 21% international stocks, 25% bonds, and 5% short-term investments; and all stock portfolio of 70% U.S. stocks and 30% international stocks. This chart's hypothetical illustration uses historical monthly performance from January 2008 through February 2014 from Morningstar/Ibbotson Associates; stocks are represented by the
S&P 500 and MSCI EAFE Indexes, bonds are represented by the Barclays U.S. Intermediate Government Treasury Bond Index, and short-term investments are represented by U.S. 30-day T-bills. Chart is for illustrative purposes only and is not indicative of any investment. Past performance is no guarantee of future results.
So how do you diversify? First, consider spreading your investments among at least the three core asset classes—stocks, bonds, and short-term investments.
You may also want to include other assets, like real estate securities, which are not always closely correlated with the core asset classes. Then, to help offset risk even more, diversify the investments within each asset class.
4. Do not try to time the market.
Attempting to move in and out of the market can be costly, particularly because a significant portion of the market’s gains over time have tended to come in concentrated periods. Many of the best periods to invest in stocks have been those environments that were among the most unnerving. Investors face long odds in trying to time the ups and downs of the market, and Fidelity data shows they tend to increase their allocations to stocks ahead of downturns and decrease their exposure just prior to market rallies.
Trying to time the market can cost you.
Past performance is not a guarantee of future results. The hypothetical example assumes an investment that tracks the returns of the S&P 500® Index and includes dividend reinvestment but does not reflect the impact of taxes, which would lower these figures. There is volatility in the market and a sale at any point in time could result in a gain or loss. Your own investment experience will differ, including the possibility of losing money. You cannot invest directly in an index. The S&P 500®, a markte capitalization-weighted index of common stocks, is a registered service mark of the McGraw-Hill Companies, Inc. and has been licensed for use by Fidelity Distributors Corporate. Source: FMRCo., Asset Allocation Research Team as of 3/31/15.
5. Invest regularly despite volatility.
If you invest regularly over months, years, and decades, you can actually benefit from a volatile market. Through a time-proven investment technique called dollar cost averaging, you invest a set amount every week, month, or quarter, regardless of how the market’s doing. Over the years, you’ll buy more shares of each investment option when prices are low and fewer when prices are high. As a result, the average price per share of your investments may be lower than if you invested all your money at once. More importantly, you avoid the temptation of trying to time the market. (Periodic investment plans do not ensure a profit or protect against a loss in a declining market.)
6. Consider a hands-off approach.
To help ease the pressure of managing investments in a volatile market, you may want to consider an all-in-one fund or a professionally managed account for your longer-term goals such as retirement. These funds provide diversification with exposure to various asset classes and investment styles in a single fund, with the added benefit of professional asset allocation.
The bottom line
Rather than focusing on the turbulence, wondering if you need to do something now, or what the market will do tomorrow, it makes more sense to focus on developing and maintaining a sound investing plan. A good plan will help you ride out the peaks and valleys of the market, and may help you achieve your financial goals.
Andrew & Peter