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Two Strategies to Manage Investment Volatility
The path to success is never straight. More like a spiral, or a zig-zag. This is especially true when it comes to investing.
In today’s environment of low yields in traditionally “safe” vehicles like savings accounts or GICs, we must look to investing for any hope of long-term returns greater than inflation and taxes.
The Emotional Challenge
The primary challenge, emotionally, is that the stock market will always be far more volatile than leaving money in the bank. Investment volatility is a fact of life.
With daily quotes, hourly updates, and by-the-minute news, the impression we’re left with is that investing is a short-term pursuit. And, of course, owning equities for a short period of time – a day, a week, even a year – is far riskier than leaving money in the bank.
Investment volatility is a normal part of every market cycle. But, in today’s information-saturated world, markets have become even more reactive. On average, market volatility is twice as high as it was before the year 2000.
It’s not surprising that we get nervous with the ever-increasing highs of the market and that we expect new lows. It’s hard not to be worried when markets are falling. And sometimes, it’s even harder not to react.
Patience Pays Off
Being patient and staying invested through market volatility pays off. For instance, if an investor stayed fully invested in the S&P 500 from 1993 to 2013, they would have a 9.2 percent annualized return.
However, if trading resulted in missing just the ten best days during that same period (that’s just 10 days over 10 years!), then those annualized returns would collapse to 5.4 percent. (Source: In JP Morgan Asset Management’s 2014 Guide to Retirement).
So what can we do to prepare for this inevitable investment volatility? How can we manage our emotions when markets get bumpy?
Well, just like just about everything else, successful investing requires a plan and a long-term view. Such a plan usually includes the use of several proven investment strategies that, over time, help to reduce stress and increase investor confidence. Here are two strategies to consider.
Strategy 1: Diversify your investments.
This is essentially “don’t put all your eggs in one basket”. At its heart, investment diversification means that you buy investments that are not concentrated in one company, industry, country or even asset class. If you ask any business owner what stock they are invested in, they will usually say, “My own”. This is an example of being extremely under-diversified, or overweight in one stock. This is also true for many executives, who tend to invest predominantly in the company they work for. Your aim with diversification is to have broad investment exposure. That is a mixture of different assets including property, stocks and bonds. You will benefit when one class out-performs, and you protect your overall returns when one category under-performs.
Strategy 2: Rebalance your portfolio.
Rebalancing involves the periodic buying or selling of assets in your portfolio in order to maintain your original desired level of asset allocation. That is the desired mix of cash, equities and bonds. Let’s say, for example, your original target asset allocation was 50 percent equities and 50 percent bonds. If your equities grow faster over a designated period – usually a year – the equity weight of your portfolio could now be 70 percent. You no longer have the desired asset allocation. In this case, rebalancing involves selling some of your equities and buying bonds to get it back to your original target allocation of 50 percent equities and 50 percent bonds.
Successful investing almost always involves rebalancing. The fact that an asset class has performed well in the past does not mean it will continue to do so. We saw this in 2008 when investors were asking their investment brokers to sell some of their equities before the market correction. What these investors were really asking was to have their investments rebalanced back to an asset mix that matched their investment risk profile.
No Substitute for Experience
Nothing can replace experience. I’ve had lots of experience in determining risk tolerance and financial needs for clients. I’ve made my fair share of mistakes, too, especially with my own money. But that has put me in a much better position to recommend investments that fit your profile and are less likely to keep you up at night. Volatility isn’t going away, but that’s not necessarily a bad thing.
Find a professional you can talk to about the right investment strategies to manage volatility and turn it to your advantage. You want a partner who can help you can navigate the zig-zag path to financial success. Without getting dizzy.