The past year was largely positive for stock market investors as major market indices notched record highs on a regular basis. Between the highs, however, were some dizzying drops, like in late July and early August when the S&P 500 experienced declines of nearly 3% on three occasions, and underwent 11 moves of more than 1% in 22 trading sessions. Stock market volatility – defined as when the market drops more than 1% over a sustained period of time – has some investors spooked, despite the continued longevity of the current bull market.
While no one can predict what this year will bring, stock market or otherwise, the new year is always a good time to revisit and assess your long-term plan with your advisor so can confidently weather whatever may come.
Market volatility over the last year has some investors feeling nervous about having their nest egg in the stock market. According to a survey recently conducted by Personal Capital and Kiplinger’s Personal Finance magazine, a majority of investors say they are very or somewhat worried about market declines.
As a result, almost half of respondents to the survey (47 percent) say they would consider reducing the percentage of their portfolio allocated to stocks in order to combat market volatility. Forty percent of these investors would consider reducing equity holdings to 25 percent of their portfolio or less. And on top of that, respondents are already holding 18 percent of their portfolios in cash.
Volatility is Causing Investors to Rethink Retirement Plans
In addition to changes to their portfolios, fears of a market downturn even have some people rethinking their retirement plans. More than four out of ten respondents (42 percent) between ages 55 and 64 said they would delay retirement if the value of their portfolio declined by more than 25 percent. Meanwhile, one in five (21 percent) said if such a decline occurred, they would consider claiming Social Security benefits sooner than they were planning.
Before making any bold moves, it’s a good idea to seek the advice of a professional financial advisor. However, only two out of ten (19 percent) respondents said they would do so before making these kinds of moves.
Your advisor is there to help prevent hasty, knee-jerk decisions that could alter your long-term plans so you stay on course and achieve your financial goals. A professional financial advisor can position you for the long-term with a balanced and diversified portfolio built to weather market cycles.
Devise a Long-Term Strategic Plan
Instead of making investment decisions based on fear or anxiety, the best way to prepare for market volatility is to work with your financial advisor and devise a long-term strategic plan. With this in place, you’ll be better prepared to weather the inevitable ups and downs of the financial markets without making emotional decisions.
While it’s natural to react emotionally to market volatility, making investing decisions based on anxiety or worry can negatively impact investment returns and your long-term financial future. The average investor consistently under-performs market indices when they try to time the market. In fact, just the opposite often occurs.
Another issue that arises with making emotional investing decisions is recency bias, a natural human inclination to place more emphasis on what is fresh in one’s mind when making investing decisions. For example, an investor with recency bias would assume that if the market has been rising or falling steadily in recent months, this will continue for the foreseeable future.
In a survey conducted by BlackRock, about two-thirds (66 percent) of retirement plan participants said they believe their investment returns over the next decade will remain about the same as they’ve been in the past. What’s more, 17 percent believe their future returns will be even higher. This bias can be especially dangerous during a long-running bull market like we’re currently experiencing, as well as after a steep market drop like the one that occurred during and after the financial crisis.
Build a Diversified Portfolio
A successful strategic investing plan will incorporate portfolio diversification, which is also the best way to optimize for market volatility. At a high level, this is the financial equivalent of not “putting all your eggs in one basket.”
So, how does portfolio diversification work? Investors first diversify by using different asset classes (equity, fixed income and alternatives). Next, they diversify within each by investing in different geographies, and then further by choosing different styles, sizes, and sectors. Finally, investors attempt to diversify away from any risk involved with a specific company or investment by investing in a large number of companies by using pooled investments like mutual funds and ETFs, or by purchasing a sufficiently large number of individual securities.
When an investor understands the different types of asset classes, sizes, styles and sectors, as well as their relationships to each other and the broader environment, they can construct their portfolios around their specific risk tolerance. The goals of different investors are usually not the same. A young couple with no children, for instance, may want to try to maximize their returns with the understanding that they may be more volatile, while a retired couple might desire steadier returns to take their family on vacation every few years.
Once you have built a well-diversified portfolio, you should maintain it by rebalancing on a periodic basis. For example, the booming stock market of the past year might have caused the equity portion of your portfolio to become over-weighted in proportion to bonds and cash. To solve this problem, you could sell some equity holdings and use the money to buy bonds or cash until the portfolio is brought back into the proper balance.
Meet with a Financial Advisor
Don’t let fear or anxiety about market declines lead you to make emotional investing decisions that could jeopardize your long-term financial success. Seek out a financial advisor to create a strategic investing plan designed to meet your long-term financial goals.
Learn more about the wealth management services Personal Capital offers here.
To learn more about the costly mistakes to avoid during volatile markets, read our free Guide to Market Volatility.