The markets sure have been finicky lately, finishing off 2015 utterly flat and having a horrible start to the New Year. Blame it on Mr. Market’s mood swings. Let’s keep it real though; the market has rallied like crazy since 2009, so a correction is not surprising. Yet, investors should not lose their heads, because what seemed like some of the worst times to get into the market actually turned out to be some of the best times. Don’t believe me? Check it out:
Great Depression (May 1932): Subsequent 5-year return of over 350%
Severe recession (July 1982): Subsequent 5-year return of over 250%
Great Recession (March 2009): Subsequent 5-year return of over 150%
I’m not saying that there’s a panic going on… yet….but I am saying that investors should be prepared an actually expect market volatility and embrace Mr. Market when he comes crying at your door.
First of all, you must have a plan. You must consider your personal goals, time horizon, risk tolerance, and other key factors in your investment strategy. If you’re 75 years old and retired, you don’t want to be heavily invested in equities. However, if you’re in your 20s during one of these recessions, it makes more sense to take advantage of the opportunity.
If you are investing in the stock market, you should continue to invest despite the volatility. If you are disciplined with your investing, and put your money in regularly, you will benefit from a volatile market due to dollar cost averaging. When you invest a set amount every week or month, regardless of how the market is doing, you’ll buy shares at varying price levels. Over time, your average price per share of your investments may be lower than if you invested all at once.
Hoarding extra cash is also an excellent strategy. Don’t decrease the amount that you’re investing, but as the market declines further, put some extra cash in. If you are regularly investing $100 per month, keep investing that money. However, keep some extra cash on the side; if there’s a day when the market decline is especially vicious, put it in.
Keep in mind that hoarding cash is a double-edged sword. You can stay out of the worst market crashes if you’re cash, but you will also miss the biggest days and recoveries that follow… not to mention the dividends in between….and inflation is going to eat your cash anyway….
Downturns and volatile periods are also excellent time to assess your reallocation strategy. If stocks are down, just take some of your money from bonds and switch it to stocks to maintain your predetermined allocation. For example, if you had a portfolio allocation of 30% stocks and 70% bonds, a drop in the stock market might weight your portfolio to 65% stocks and 35% bonds. You’ll just take that extra 5% and move in back into stocks, buying at a lower price to boot. Plus, a well-diversified portfolio can significantly lower your portfolio risk.
With all this being said, worrying about what the market will do tomorrow won’t do you much good. You should develop and maintain a long-term investment plan that will help you ride out the highs and lows of the market to eventually achieve your goals.