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Avoid making decisions motivated by emotion and fear, advises Jeff Witz, CFP.
With fears about the coronavirus (COVID-19) causing the markets to fluctuate significantly, should I make any adjustments to my investment strategy?
The markets have certainly been a roller coaster lately. At the end of February, the Dow experienced its “first” largest single-day drop, down 1,191 points, then posted its largest single-day gain, at 1,293 points, a couple of days later. On March 10, the Dow beat its single-day loss record again by posting a jaw-dropping 2,021-point loss only to follow this up with a larger 2,997-point drop on March 16.
This volatility isn’t unexpected when you have a stock market that was consistently setting new record highs come face to face with a potential global health threat. With a global pandemic causing countries to limit trade and social distancing limiting people’s ability to purchase goods, it is likely that a highly volatile environment will remain for the short term.
As investors, it is critical not to overreact. You need to block out the surrounding noise and follow your investment strategy in the face of volatile markets. Actions based on emotion and fear can cause you to make mistakes that can negatively affect your long-term investment performance. In 2018, we wrote an article during another period of high volatility and provided some insights for investing in these environments. We would like to share those with you again.
Also by Jeff Witz, CFP: I made an excess contribution to my Roth IRA; how do I fix it?
Fight the impulse to sell your holdings if the markets are dropping. Selling after drops can make temporary losses permanent and difficult to recover. Sticking to your investment strategy, although it can be difficult emotionally, may be healthier for your portfolio. It is important to continue monitoring your investments but remember the long-term reasons the investment is in your portfolio. What role is it playing? If it is still a good fit, holding the investment may be the better long-term strategy.
Remember that you are investing for the long term. Markets have always fluctuated up and down, and during your lifetime, you’re likely to experience several significant declines. Investors should ignore the noise and stay disciplined to the investment strategy they designed. The strategy was created specifically to avoid falling into these pitfalls.
Review your risk tolerance. Risk you took on years ago may no longer make sense given your current circumstances and stage of life.
Next: Make sure your portfolio is well diversifiedMake sure your portfolio is well diversified. Volatile markets have a way of exposing improperly diversified portfolios.
Rebalance your portfolio. Market volatility can skew your allocation from its original target. Certain assets will be more affected by market swings and will move outside their target allocations. Rebalance your portfolio by selling positions that have become overweight in relation to the rest of your portfolio and move the proceeds to positions that have become underweight.
If you must trade during volatile markets, there are defensive steps you can take to protect your positions. Stop orders and stop-limit orders can help shield unrealized gains or limit potential losses on an existing position.
Consider adding defensive assets such as cash and cash equivalents, Treasury securities, and other U.S. government bonds. These can help stabilize a portfolio when stocks are slipping.
If I want to take advantage of the down market, is there a preferred way to invest?
First, evaluate if you are in a financial position to invest more and proceed with caution. If you determine you are able to invest during a volatile environment, the best approach is to do so over a period of time. It is impossible to tell when the markets have hit their bottom. Don’t try to guess and invest everything in one lump sum. If markets continue to decline, you could potentially lose a significant amount.
It is better to break up the investment into smaller increments. If you are wrong, you are not wrong with all the money you planned to invest. This strategy is called dollar-cost averaging. With a dollar-cost averaging strategy, it is best to select 1 day a week or 1 day a month to invest a smaller percentage of the total amount you planned to invest. By selecting a day and sticking to it, it will allow you to ignore the outside noise. If markets continue to decline, you are incrementally buying on the downslope and will be in a good position when markets recover.
The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice.