Disciplined Investing in Volatile Markets

| May 11, 2020 | 0 Comments

The past few weeks have been a wild ride, to be sure. With financial markets selling off and government efforts to contain the coronavirus outbreak starting to crimp both economic and personal activity, it’s very reasonable to be concerned about what will happen in the coming months. Frankly, there are about as many theories as there are analysts as to how the outbreak will progress and how our economy will perform as a result.

What is absolutely certain is that economic activity will falter. With most non-essential stores closing across the state (and soon much of the country) and many workers working from home instead of their offices, the flow of goods and services is bound to slow. That has been reflected in capital markets over the past weeks as investors try to figure out how bad the damage will be and how long it will last.

What is equally certain is that it will not last forever, and things will get better in time.

When traders in financial markets begin to sell indiscriminately, there’s little that can turn the tide in the short run. More importantly, because the market volatility means prices will swing wildly in both directions, timing an exit point and corresponding re-purchase point becomes nearly impossible. Nearly every study or attempts to time markets that we’ve reviewed has shown that there is no statistically demonstrable difference between skill and luck.

It’s attractive to think that there is some way to hedge out the possibility of losing money in the stock market. While it’s true that there are options that will protect you from losses, these options are so expensive to own over the long-term that they eat away any gains from owning stocks. When the panic selling begins, the price of these protective options rises so quickly that the cost of purchasing them after the fact offsets any benefit you might have gained by owning them.

For these reasons, the primary strategy for disciplined investors is as follows:

Focus on your long-term plan. There’s a reason investment advisors spend time talking with clients about how much volatility they can handle in their portfolios. Understanding your investment objectives and your tolerance for risk is how we identify a long-term strategy that will hold up throughout good times and bad (like the past month).

Begin with a balanced portfolio. Holding a mix of assets like stocks, bonds and real estate means that your portfolio will not rise as fast as the stock market when times are good. But it also means that your portfolio should hold up better than the stock market in periods like the last month. How much you invest in these diversifiers depends on your goals and your ability to the ups and downs that are a part of investing in risky assets like stocks.

Stick to that target portfolio. If your portfolio was properly constructed, it will be designed to meet your objectives over a longer time period than just a few weeks. That means that the kinds of volatility we have experienced recently were part of the plan. That doesn’t make it enjoyable, but a properly constructed portfolio assumes that weeks and months like this will happen.  

Rebalance. This is a critical component of an investment strategy. When stocks sell off, they get cheaper. The most reliable strategy for long-term success is to buy assets that have become cheap and to sell assets that have become too expensive. Since it is nearly impossible to determine when these conditions exist, prudent investors periodically and strategically rebalance their portfolios back to their target allocations during markets like this.

There is no way to know when the sell-off in stocks will end. But it is certain that it will end at some point. It is also nearly certain that stock markets will start to rise again long before we as investors feel comfortable buying stocks. Those who sell out today will most likely miss this recovery. Those who can remain disciplined and stick to their strategy will come out okay in the long run.

And then we can all look back and tell our stories about how crazy 2020 turned out to be.

This column is prepared by Rick Brooks, CFA®, CFP®. Brooks is director/investment management with Blankinship & Foster, LLC, a wealth advisory firm specializing in financial planning and investment management for people preparing for retirement. Brooks can be reached at (858) 755-5166, or by email at rbrooks@bfadvisors.com. Brooks and his family live in Mission Hills.


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