Acting based on fear can negatively affect long-term investment performance, write Jeff Witz, CFP, and David Zemon.
The markets have been a roller coaster lately. Should I have a different investment strategy during more volatile periods?
Stocks have been experiencing a great deal of volatility lately. The CBOE Volatility Index has seen multiple days with extremely sharp moves, the most since 2014. Higher volatility reflects greater price swings in both positive and negative directions and is a general measure of risk and uncertainty about the future direction of the markets.
The recent rise in volatility has been driven by a number of factors. Concerns that drove the stock markets lower in March included the Trump administration announcing that it would impose roughly $50 billion in tariffs on imports from China, tech giant Facebook losing over $60 billion in value after the company came under fire for failing to protect users’ data, and the Federal Reserve electing to increase interest rates. While any of these incidents alone would cause some reaction from the markets, they all came in quick succession, causing the markets to fluctuate significantly.
As investors, it is important not to overreact to outside noise and stray from your investment strategy in the face of volatile markets. Acting based on emotion and fear can cause you to make mistakes that can negatively impact your long-term investment performance. During periods of higher volatility, consider some of the following tips:
Fight the impulse to sell your holdings if the markets are dropping. Selling after drops can make temporary losses permanent and difficult to recover from. Sticking to your investment strategy, while 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. Timing when the market has hit a bottom is nearly impossible. 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 life stage. If you are less open to risk, consider adjusting your target asset allocation.
Make sure your portfolio is well diversified. Volatile markets can expose improperly diversified portfolios. Review your portfolio and target asset allocation and make sure your investments are well diversified across a range of asset classes.
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.
Consider defensive measures for your portfolio. 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. In addition, defensive assets, such as cash and cash equivalents and Treasury securities and other U.S. government bonds, can help stabilize a portfolio when stocks are slipping.
Following these tips will help you stay disciplined in your investment strategy and avoid making emotional mistakes.
Next: How does inflation impact retirement savings?How does inflation impact my retirement savings?
Inflation is the increase in the cost of goods and services over time. What $100 is able to purchase today is going to be a lot less than $100 can purchase 20-30 years from now. Let’s look at an example. At 3% inflation, $100 today will be worth only $67.30 in 20 years, which is a loss of one-third of its value. At 35 years, this amount would be further reduced to just $34.44.
It is crucial that you take inflation into account when determining how much retirement savings you will need. If you hope to maintain a certain standard of living over a 20- to 30-year retirement, you must account for the increasing cost of goods and services that will occur over that time period. To account for inflation, your long-term retirement strategy must balance short-term income needs and long-term investment growth.
The information in this column is designed to be authoritative. The publisher is not engaged in rendering legal, investment, or tax advice.