Market wobbles are nothing new but they can strike a serious blow to investors’ confidence levels, dramatically changing how they view the market.
The second week of October saw the Dow Jones Industrial Average slide 832 points, the worst decline since February. In AAII’s Investor Sentiment Survey for that same week, the number of investors who took a bullish view dropped by 15.1 percent, while the number who adopted a bearish outlook increased by 10.3 percent.
Investors often seem surprised by volatility, even though they shouldn’t be.
“The steady growth of the stock market since early 2009 has certainly lulled many investors into a false sense of reality — one in which assets grow steadily with few interruptions,” says Kevin Cooper, vice president and head of investment research at AMG Funds. “The volatility of early 2018 and again over the last several weeks is an unwelcome reminder that volatility is, in fact, normal.”
When investor confidence falters, the result can be emotion-driven decision-making. This, says Cooper, leads investors to consistently underperform the major market indices over time.
Bob Schmidt, manager of the Brandes Institute in San Diego, says investors know they should be rational and focus on the long term, buying low and selling high. But it doesn’t always happen that way.
“We get excited, we get greedy, we get fearful,” he says. “That’s natural, but we can’t allow our emotions to dictate our investment decisions — or erode our confidence.”
Whether volatility is real or perceived, it’s in your best interest to keep a level head.
Check your perspective. When stocks dip, investors’ first reaction may be to fear the worst. Ben Barzideh, wealth advisor at Piershale Financial Group in Barrington, Illinois, says investors can remain confident by understanding that increased volatility isn’t an automatic precursor to a market crash.
“It’s just a sign that there are some short-term scenarios or events that the stock market is trying to price in,” he says.
Investors also need to look beyond what’s happening with stock prices in the moment. Ed Handschuh, CEO and co-founder of cryptocurrency exchange platform 1Konto, says that a pullback is not only overdue, but healthy in the current bull market.
“We’re in a unique situation where the Federal Reserve is raising rates, gross domestic product is at 4.1 percent and the market has kept climbing,” Handschuh says.
He acknowledges that some investors could choose to get out of stocks to lock in gains, producing a choppy market through the end of the year. What investors must remember is that historically, volatility tends to peak in October, before smoothing out in November and December.
Practice self-awareness. When volatility triggers emotional thinking, the best way to combat those biases is to be aware of them, says Frank McAleer, senior vice president of wealth, retirement and portfolio solutions at Raymond James.
Loss aversion, meaning the preference for avoiding losses over acquiring gains, is one of the most prominent biases. In a volatile market, this most often manifests itself as panic selling, something you may regret if volatility is short-lived.
Mariann Montagne, portfolio manager at Gradient Investments in Arden Hills, Minnesota, says investors tend to see several consecutive days of declines and assume that trend will continue. But, they can get through those periods confidently if they’ve developed a strategy for curbing emotional biases.
[Read: 3 Times When You Should Sell a Stock.]
“Investors tend to be more confident when their holdings are going up in value, and less confident when they’re coming back in price,” Montagne says. “When prices are high, that’s the time to re-examine valuations and set selling prices. When the prices have come back, that’s the time to take advantage of the discounts.”
Tony Drake, CEO and founder of Drake & Associates in Waukesha, Wisconsin, recommends buying solid companies or an exchange-traded fund that tracks the S&P 500 when volatility lowers prices.
However, it may be wise “to steer clear of emerging foreign markets because of concerns about inflation and currencies,” Drake says. “Tariffs may adversely affect big manufacturing companies, so it may be good to stay away from those investments for the time being as well.”
Don’t allow a lack of confidence to freeze you like a deer in headlights.
“Now is the time for investors to take an active approach,” says Adam Phillips, director of portfolio strategy at EP Wealth Advisors in Torrance, California. That doesn’t mean, however, that it’s time to make drastic changes to your investment strategy. It’s simply being aware of what you own and why you own it.
“As we move further along in the market cycle, we’re likely to see greater dispersion between the market’s winners and losers,” Phillips says.
Stay tuned in. Scheduling routine check-ins with your portfolio is particularly helpful during bouts of volatility.
“Having that regular review can make you feel like you’re getting something done, which can build confidence,” says Terry Siman, managing director at United Capital’s Philadelphia office. Likewise, he says monitoring your progress toward your goals can be a confidence booster when unexpected volatility arises.
If the markets go on a two-or three-day dive after weeks of solid gains, the investor who’s been paying attention is less likely to be thrown off by losses, Siman says. But, “an investor who has no clue what’s been happening could easily overreact to a sudden downturn.”
Regularly reviewing your portfolio can also help you gauge when it makes sense to build up cash reserves during volatile periods and when to maintain your current asset allocation.
“Prudent diversification is always good advice, but one should not simply rely on historical patterns of correlation between the stock market and fixed income investments,” says Leonid Kogan, chief investment scientist at online wealth management platform 55ip.
When inflation is expected to climb, for instance, that can lower the values of both markets. A cash cushion can offer the best protection in uncertain markets.
But, Kogan says, cash position has a cost: investments sitting in cash-like instruments do not participate in the broader market. On the positive side, “a cash cushion offers a valuable option of re-entering the market following a decline, as well as a degree of resilience to psychological pressures that build up following market declines.”
The confident investor knows where the biggest risks are waiting and protects themselves accordingly, Siman says. Remember, however, that overconfidence can be just as dangerous as a lack of confidence in a volatile market.
“Investors think the market will continue to go up or they can beat the market,” says Alex Sutherland, investment advisor and president of LifePlan Group in Raleigh, North Carolina. “Either way, they could find themselves in a difficult situation.”
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