Last week, stock markets around the world corrected in a violent selloff. Most of the major indexes were down more than 15% at their lowest levels due to fears of a Coronavirus pandemic and the economic impact that would have. This, just a little more than a week from the S&P 500 making record highs on an almost daily basis. In essence, a correction was due, and it came with a searing intensity.
Now what? What should retirees and long-term investors do? It is an interesting question as I am hopeful, if you are invested, your portfolio is properly diversified. A properly diversified means two things:
- You have eliminated single stock risk by not investing so much of your investments in any one stock (or any single investments) that its collapse would financially devastate you. This problem was solved decades ago with the advent of the mutual fund and more recently, the ETF.
- Your portfolio is composed of various types of investments with low or negative correlations to smooth out the bumps in volatile markets. Most portfolios should include large-cap U.S. stocks, small-cap U.S. stocks, international stocks, emerging market stocks, bonds, real estate, and cash. Understanding what allocation is right for your age, goals, and risk tolerance is perhaps the single most important thing you can do in investing. Far more important over the long-term than market timing or stock picking.
If we assume that you have at least some level of diversification for both of the above, let’s then discuss how to manage the current volatility:
Young investor: If you are under 50 years old and have a minimum of 10 years before you will need to tap these assets, there are a few things you can do to enhance your long-term return using this volatility to your advantage:
- Rebalance: Rebalancing your portfolio is simply bringing your portfolio back into alignment with the original allocation percentages. Essentially, you will sell what has done well and buy what has done poorly. This is a fantastic way to take advantage of market volatility and add to your investment performance over time.
- Invest more: Although we tend to encourage people to always invest when they have money for the long run as it will perform well over a long period of time, market selloffs are particularly good times to add new cash. It allows you to accumulate more shares for the same dollars and accumulation of shares should be young investors focus. However, be careful not to put all your free cash to work at the first sign of a dip. We had several people call us after the first 3% selloff wanting to put cash in and buy the dip. We advised patience and began encouraging new money when the market was down more than 10%. Any 3% move is not a pullback, it’s a fluctuation. Invest new money in stages as the market falls. Remember, you don’t have to invest new money so keep some on the sidelines for real panics.
Older Investor: Periods of extreme market volatility are especially difficult on older investors. If you plan to draw on your portfolio in less than 5 years or are currently drawing from it, it can be downright scary. However, the key is being properly diversified before the volatility occurs, not being reactive to it. By the time the market has fallen 15%-20%, if you were not diversified properly, it is too late. However, for those who were diversified coming into last week’s selloff, here are some steps you can take to take advantage of the market opportunity and ease the pain:
- Rebalance: As with younger investors, rebalancing during a time of extreme fluctuations is always a good idea.
- Use Conservative Investments for Distributions: Ideally, you do not want to sell stocks when prices are down to satisfy your distributions. As prices contract, you are required to sell more shares to receive the same dollar amount which can eat away at your portfolio quicker than anticipated. Ideally, when stocks fall, you will want to use cash, bonds, or any other high performing investment to satisfy your distribution requirements. Liquidate these investments while they are up, performing well, and you have to sell fewer to meet your cash flow needs. This strategy has the added benefit of helping rebalance the portfolio as selling what is performing well will bring the portfolio allocation back into alignment.
Market fluctuations are the price of admission when investing in a diversified portfolio. Although the outsized performance the stock market furnishes over the long-term is necessary to outpace inflation for just about all investors, it can sting in the short-term. Avoid checking balances daily, rebalance where you can, and if possible, invest more. When you look back over your performance in 10+ years, you will be extremely happy with your performance and the Coronavirus will be a buzzword from the past like SARS or Brexit. Happy Investing!