Looking to where you are going, instead of where you have been
There’s an old story of a man who was afraid of heights, so he decided to conquer his fear by going rock climbing. A guide was on hand to help him, but as he was dangling from the edge of the cliff, he looked down. The sight made him freeze.
The guide gave him some simple advice: “Don’t look where you don’t want to go.” By this simple twist on a familiar goal-setting meme, the man was able to complete his climb.
Market volatility can either be your best friend or your worst enemy during these periods, dependent on your approach to the uncertainty. It can be difficult to tune out the numerous doom and gloom stories that appear on news outlets during these periods, especially when it concerns the financial assets your hard-earned money is invested into. How can you avoid becoming your own worst enemy? The following tips are meant to be a guide during rough patches of the market cycle and how to best frame these thoughts within the broader scope of your overall investment strategy.
Do not focus on Short Term Performance
While it can be unnerving to witness a portion of your portfolio decline by a sizable amount, it is important to remember, over the short run, swings in the market occur routinely. Ironically, short-term price fluctuations (seen in riskier assets) can be linked to their favorable long-term returns. It’s during those times that it’s essential to retain – not relinquish – control over your investments. Overwhelmingly, investors use “gut instinct” which impacts portfolio results and fuels the engine of fear/greed in markets. This strategy of “running for the exits” as assets move down and pouring into last year’s winner as investors chase the “hot dot” has the potential to magnify underperformance. I believe resisting these temptations of following the herd is critical to investor’s success.
Remind Yourself of Your Initial Investment Strategy
If market conditions take a turn for the worst, it is often important to remember the reason for your initial investment strategy and allocation implemented through your advisor. A well-rounded investment strategy is as important to an investor as a flight plan is to a pilot. Without clear plans to deal with weather, traffic, instrument and mechanical failures, etc., a pilot has little to no control over the possible outcomes of a trip. The plane could arrive to its destination late, a little battered and bruised… or maybe it doesn’t make it there at all. Similarly, investors need a clear plan to manage the outcomes of each investment as well as the portfolio.
Balanced portfolios are designed to help investors participate in market upswings while at the same time hopefully lessen a portion of losses on the downside. The below chart illustrates the benefits to a balanced portfolio when compared to holding a single asset class over time.
While the returns from a pure equity portfolio are enticing, the peaks and valley associated with such a strategy can take a toll on many investors’ psyches. When an investor gets pushed out of their comfort zone their natural impulse is to respond and this reaction can lead to some ill-advised moves. A balanced portfolio helps to alleviate this concern.
Do not try to Time the Market
Many investors believe by timing their entrance or exit in the market it will lead to superior results. In reality, achieving excess returns by correctly timing the market is extremely difficult even for the most seasoned portfolio managers. This strategy tends to be about as reliable as picking a Super Bowl winner before a regular season game has been played. A sizable portion of the gains the market experiences occur during a limited number of trading days, and missing out on some of them can have a large impact on your portfolio results.
During large swings in the market investors often get caught up in the euphoria or panic because they feel there’s safety in numbers. The natural reaction is to see what everyone else is doing, to guide your own actions, when the best course is often just the opposite. Many sell out at the first sign of a market dip or buy once the market has already experienced much of its gains. This type of investor behavior is evidenced by the below chart showing cash flows into and out of the S&P 500 at different points of the market cycle. As you can see, inflows were highest in good periods such as 2000 and 2006 and outflows peaked during recessionary periods such as 2002 and 2008.
One way of hedging any of the aforementioned situations is to dollar-cost average contributions into the market. This strategy generally ensures that the investor’s average price per share is lower than the average price per share over a given period.
Often, we listen to market and media noise regarding things that never really matter. However, often it causes us to look where we are not going, instead of where we are going. By now you’ve heard the wisdom of staying put, and not moving in and out of investments as markets correct. Yet, often this difficult task is compounded by distractions pulling us away from where we really want to go.
Stephen L Thomas
Linden Thomas and Company
516 N. Tryon Street
Charlotte, NC 28202
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The opinions express in this report are those of the author and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared for information purposes only, is not all encompassing and is not a solicitation or offer to buy any security or instrument or to participate in any trading strategy. Investing involves risk including the possible loss of principal. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. Diversification does not guarantee profit or protect from a loss in a declining markets. Since each person’s situation is different you should review specific investment objectives, risk tolerance, and liquidity needs with your financial professional before selecting a suitable savings or investment strategy. Past performance is not a guarantee of future results and there is no guarantee that any forward looking statements made in this communication will be attained.
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