In light of the recent volatility in the stock market, it’s important to remember that no one can accurately predict the day-to-day movements of the markets – and that markets move in both directions.
Many people react hastily to periods of short-term volatility, and in too many cases their decisions wind up hurting them in the long term. Why do they react?
Primarily because they’re scared.
The average investor can become anxious when the markets grow more turbulent because they don’t understand how fluctuations in the market will impact them, and they want to stem their losses.
They don’t have the correct expectations of how their investments should perform.
A well-planned portfolio takes market fluctuations into consideration and is designed to weather bouts of volatility. Investors reacting to short-term volatility likely failed to do enough upfront research and planning for their portfolios to appropriately handle the risk.
They don’t recognize the commonality and temporary impact of large short-term market declines.
Although they've been less frequent in recent years, corrections in the market are actually quite common. The table below lists the top 10 largest single-day drops in points and where they ranked all-time. The recent single-largest dollar drop on February 5, 2018, was ranked only 108th all-time in percentage dropped, while the $831.84 drop in October 2018 was not even in the top 300.
All Time Rank
February 5, 2018
February 8, 2018
October 10, 2018
December 4, 2018
September 29, 2008
October 15, 2008
March 22, 2018
September 17, 2001
December 1, 2008
October 9, 2008
Source: Morningstar Direct
While a 500-point drop in the market may sound staggering, the volume drop is not as significant or painful today as it would have been 10 years ago. A 500-point movement in a 20,000+-point Dow Jones Industrial Index (the Dow) represents a 2.5% change. A more common movement of 200 to 300 points is only a 1% to 1.5% change, which is far from unusual – or detrimental overall in today’s markets.
In addition to single-day drops, periods of volatility also occur on a rather frequent basis with a greater magnitude. Consider that the market has averaged a decline of ≥10% about once every year, ≥15% every two years, and ≥20% or more every 3.75 years.1 While this may be disturbing to some investors, it’s important to note that in every case, these downturns were temporary and the markets were able to eventually bounce back.*
They give the media too much power over their decision making.
The media stays in business by generating ratings, and volatile markets can draw the attention of confused and concerned investors.
While the financial media may accomplish their objectives and realize great ratings or lots of page views, paying too much attention and making impulsive decisions based on what you hear or read, without broader economic or historical context, may hinder the achievement of your financial goals. We encourage you to tune out the noise and take a perspective that is consistent with your timelines, goals, and objectives.
Misguided perspectives cause people to make bad decisions.
A common and largely unsuccessful strategy is to get out until the markets “calm down.” Timing the market can be tricky at best; and unless you know the best time to get out and the best time to get back in, the value of your investments will likely take a hit. And it only takes 1 or 2 bad decisions to irreparably damage your portfolio.
Reacting to short-term movements in the market changes your investment time horizon, and usually not in a positive manner. Your portfolio planning should be based on when you plan to begin making withdrawals. If your plan was established with a 20- or 30-year time horizon and you start selling when the market drops 5%, your time horizon has shortened and your portfolio will not mature according to plan.
Consider the following analogy: You’re in a 30-foot boat sailing across a body of water, and 50 yards from shore you’re suddenly surrounded by sharks. Sure, it’s scary; but you’re in a boat and protected from the sharks and so you can keep going. You’re much safer in the boat than you would be if you jumped out and swam to shore.
Your well-devised portfolio is the boat in the above analogy; and the market volatility – as well as those looking to profit from your panicked sale of assets – are the ring of sharks. You face more risk selling your assets than you do by riding out the volatility and taking the boat safely to shore.
How can you withstand volatility? Plan for it.
Your best chance at safely riding out volatile markets is to create a portfolio that is prepared for both upswings and downswings. This requires research, analysis, and making good decisions on what to buy upfront to ensure your portfolio can react in a market that’s less than ideal. It’s also important to understand what your plan can withstand at times of higher risk in terms of asset allocation and withdrawal rates.
If you’re not close to retirement, your long-term investments can better withstand volatile market movements. But if you’re closer to or in retirement, you need to consider how normal corrections in the market will affect your withdrawals and portfolio with a risk allocation plan.
The portfolios we help our clients establish, like the financial plans we build, are devised with a long-term objective in mind – one that accounts for periods of volatility. Because we recognize there will be additional periods of short-term volatility to come, we offer the following recommendations:
- Tune out: turn off the TV, stay off the internet, and pay the media no mind
- Don’t look at your investment accounts every day
- Don’t make split-second decisions that cannot be reversed
- Revisit your plan on a regular basis
Nothing about the recent volatility has changed how we advise our clients about their investments or expectations. We encourage you to tune out the noise and take on a perspective that is consistent with your timelines, goals, and objectives.
*Past performance is no guarantee of future results.
1. The Capital Group Companies, Inc. Keys to Prevailing Through Stock Market Declines. https://www.americanfunds.com/individual/pdf/shareholder/mfgebr-051_recovrbr.pdf. Accessed January 22, 2019.