Has the market knocked you down? Here are a few tips on how to hang in there during a few rounds of market turmoil.
Have you ever worked a shift where nothing clicked? The CT scanner was down. On call docs refused to admit patients. The nurses couldn’t get IVs. You felt helpless and couldn’t control anything. You might feel the same way with your investment portfolio. As I discussed in September, you should have had enormous returns over the past two years, but what followed in July and August was brutal. Look at the returns of various asset classes over those two months:
With the wild swings in stock markets around the world, you may be feeling anxiety, fear, and powerlessness. While these are completely natural responses to events beyond your control, acting on your emotions can end up doing you more harm than good.
The increase in market volatility was an expression of uncertainty over the confluence of events, from the possible US government default to economic meltdown in Europe. Anytime perceived risk is high, it takes lower prices to induce you to invest in riskier assets. That’s why investors fled from stocks to the perceived safe havens of bonds and gold. This resembled the events of 2008, when the collapse of big financial institutions and the sub-prime mortgage crisis triggered a global market crisis.
Unfortunately, no one knows for sure what’s going to happen next. That’s the nature of risk, and it’s that uncertainty which has led to stocks having a far higher return over time than so called “risk free” investments such as very short term US government bonds (called Treasury bills).
It’s tough for you to invest in this difficult, risky, and highly uncertain environment. So I’d like to help you make living with this volatility more bearable.
From Hopelessness to Hope
Remember that markets are unpredictable and do not always react the way the experts predict they will.
The recent downgrade by Standard & Poor’s of the US government’s credit rating, following protracted and painful negotiations on extending its debt ceiling, actually led to a strengthening in bonds. Instead of bond prices going down, they went up! So even if Standard and Poor’s thinks we’re not AAA rated, you as an investor should still act as if we are. The “experts” got it completely wrong on this one.
Quitting the stock market at a time like this is like running away from a sale.
While prices have been discounted to reflect higher risk, that’s another way of saying expected future returns are now higher. And while the media headlines proclaim that “investors are dumping stocks,” remember someone is buying them. For every seller there has to be a buyer. When stock prices go down and people sell, someone else is on the opposite side of the trade and is buying–every time. There is no such thing as “orphan” shares–shares that no one owns. Long term investors are often the ones buying. You should be part of that group.
Market recoveries can come just as quickly and just as violently as the prior correction.
For instance, in March 2009—when market sentiment was last this bad—the US stock market turned and put in seven consecutive months of gains totaling almost 80 percent. This is not to predict that a similarly vertically shaped recovery is in the cards this time, but it is a reminder of the dangers for long-term investors of turning paper losses into real ones and paying for the risk without waiting around for the recovery. When you buy stocks, you’ve actually bought risk so you may as well stick around for the returns.
Never ever forget the power of diversification.
While stock markets have had a rocky time in 2011, bond markets have flourished—making the overall losses to a balanced portfolio more bearable. Diversification spreads risk and can lessen the bumps in the road. Financial crises cause all risky assets to go down together. What saves you and keeps you in the game are bonds–the best diversifiers of a portfolio when you need them the most.
Markets and economies are different things.
The economy is only one of many factors that drive stock market returns. They aren’t perfectly related. Also, the world economy is forever changing, and new forces are replacing old ones. While advanced economies seek to repair public and financial balance sheets, emerging market economies are thriving. Today’s losers might be tomorrow’s leaders. A globally diversified portfolio takes these shifts into account.
Nothing lasts forever.
Just as you should temper your enthusiasm in booms, you should keep a reserve of optimism during busts. And just as loading up on risk when prices are high can leave you exposed to significant market drops, dumping risk altogether when prices are low means you can miss the turn when it comes. As always in life, moderation is a good policy.
Words of Wisdom From My Hero
As John Bogle, one of my investing heroes, has said: “When reward is at its pinnacle risk is near at hand.” We’ve had an incredible two years of market gains. A well thought out investment plan means that you should rebalance out of stocks during their climb upward (as in the past two years) to keep your risk appetite in check. Those rebalancing events mean that downturns should affect you less. If you’ve reached closer to your goals from the last two years of gains, then your need to take risk has dropped and so should your allocation to stocks.
“It’s always darkest before dawn.” It’s when things look the gloomiest, when there’s a constant barrage of bad news, when you feel like your portfolio is falling off a cliff...that’s when risk premiums–the returns of riskier assets such as stocks over safer assets–are the highest. Capturing those returns takes unwavering discipline since no one knows when those returns will come. So just when things look the darkest, realize that the first flicker of light may be just over the horizon.
The market volatility is worrisome, no doubt. Your feelings are completely understandable. But through discipline, diversification, and understanding how markets work, the ride can be made bearable. At some point, value will re-emerge, risk appetites will re-awaken, and if you acknowledge your emotions without acting on them, relief will replace anxiety.
Setu Mazumdar, MD practices EM and he is the president of Lotus Wealth Solutions in Atlanta, GA www.lotuswealthsolutions.com