On Friday, the Dow closed down almost 600 points (2.34%) on trade war fears. However, the markets are not tanking as we write this piece. In fact, overall market temperatures have been so mild for so long, many newer investors and us seasoned investors have forgotten what volatility feels like and how panic-inducing those times can be.
Experience and evidence alike show us how severely volatile markets test investor resolve, sabotage otherwise solid plans, and just plain hurt. We’ve also seen how damaging it can be to act on rash fear rather than rational resolve during market downturns.
Just as we prepare for other emergencies by practicing how to avoid deadly blunders in the heat of the moment, here are 7 timely actions you can take as financial market volatility returns … and, frankly, even when it’s calm.
- Don’t panic. It’s easy to believe you’re immune from panic when the financial sun is shining, but it’s hard to avoid indulging in it during a crisis. If you’re entertaining seemingly logical excuses to bail out during a steep or sustained market downturn, remember: It’s highly likely your behavioral biases are doing the talking. Even if you only pretend to be calm, that’s fine, as long as it prevents you from acting on your fears.
“Every time someone says, ‘There is a lot of cash on the sidelines,’ a tiny part of my soul dies. There are no sidelines.” – Cliff Asness, AQR Capital Management
- Remember the evidence. One way to ignore your self-doubts during market crises is to heed what decades of practical and academic evidence have taught us about investing: Capital markets’ long-term trajectories have been upward. Thus, if you sell when markets are down, you’re far more likely to lock in permanent losses and pay avoidable taxes than come out ahead.
“Do the math. Expect catastrophes. Whatever happens, stay the course.” – William Bernstein, MD, PhD, financial theorist and neurologist
- Manage your exposure to breaking news. There’s a difference between following current events versus fixating on them. In today’s multitasking, multimedia world, it’s easier than ever to be inundated by late-breaking news. When you become mired in the minutiae, it’s hard to retain your long-term perspective. It is important to stay focused on your destination and look beyond the headlines when markets are volatile.
“Turning Out the Noise takes viewers on a journey through the lost decade, featuring the media’s amplified coverage of headline events and pointing to the positive outcome that a disciplined investor could have experienced in the recovery.” – Dimensional video
- Reconsider your risk tolerance (but don’t act on it just yet). When you craft a personalized investment portfolio, you also commit to accepting a measure of market risk in exchange for those expected market returns. Unfortunately, during quiet times, it’s easy to overestimate how much risk you can stomach. If you discover you’re miserable to the point of breaking during even modest market declines, you may need to re-think your investment plans. Start planning for prudent portfolio adjustments, preferably working with an objective advisor to help you implement them judiciously over time.
“Our aversion to leverage has dampened our returns over the years. But Charlie [Munger] and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need.” – Warren Buffett, Berkshire Hathaway
- Double down on your risk exposure – if you’re able. If, on the other hand, you discover you’ve got nerves of steel, market downturns can be opportunities to buy more of the depressed (low-price) holdings that fit into your long-range investment plan. You can do this with new money, or by rebalancing what you’ve got (selling appreciated assets to buy the underdogs). This is not for the timid! You’re buying holdings other investors are fleeing in droves. But if you’re able to do this and hold tight, you’re especially well-positioned to make the most of the expected recovery.
“Pick your risk exposure, and then diversify the hell out of it.” – Eugene Fama, Nobel laureate economist
- Tax-loss harvest. Depending on market conditions as well as your own circumstances, you may be able to use tax-loss harvesting to turn financial lemons into lemonade during market downturns. A successful tax-loss harvest lowers your tax bill without substantially altering or impacting your long-term investment outcomes. This action is not without its tricks and traps, however, so it’s best done in alliance with a financial professional who is well-versed in navigating the challenges involved.
“In investing, you get what you don’t pay for.” – John C. Bogle, Vanguard founder
- Talk to us. Remember its’ when not if market volatility strikes again … we don’t know how severe it will be, or how long it will last. But sooner or later, we expect the markets will correct again, just as we also expect they’ll eventually recover and continue upward. We hope today’s drill will help you be better prepared for “next time.” We also hope you’ll be in touch if we can help. After all, there’s never a bad time to receive good advice.
“In the old legend the wise men finally boiled down the history of mortal affairs into the single phrase, ‘This too will pass.’ Confronted with a like challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY.” – Benjamin Graham, economist, “father of value investing”
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