Four Strategies to Reckon with the Stock Market Roller Coaster

    After a quiet, steady and sometimes spectacular bull market in 2017, stock market volatility returned with a stomach-churning vengeance early in 2018, conjuring unpleasant memories of the major recession of a decade ago, and reminding investors just how important it is to take steps to protect their assets from the wild, unpredictable market swings that are all too common these days.

    2017 went down as one of the least volatile years on record in the stock market. But the relative quiet ended abruptly in February 2018, when the S&P 500, a popular index that tracks stock market performance, recorded three drops of greater than two percent in the span of five days. Within a month, however, stocks had mostly recovered what they lost. After a blip, the bull market was back.

    Short-lived as that blip was, it served notice to investors that staying true to certain investing fundamentals is the best defense against the vagaries of the stock market. “There’s a tendency to pay much closer attention when the stock market drops,” observes FPA member Molly Balunek, CFP® who heads Laurel Tree Advisors, a comprehensive financial planning firm in Cleveland, OH. “People say, ‘The market has been so volatile, what trades do we need to make?’”

    The answer in many cases may be none. But volatility can tempt people to behave irrationally and take actions in the moment that may not be in their best financial interests. To resist that temptation, financial professionals suggest following the four investing fundamentals explained below:

    1. Ensure assets are appropriately diversified.  Diversification means strategically allocating assets across and within the various classes: stocks, bonds/fixed investments, cash and perhaps other categories, such as real estate or commodities. Diversification applies to a person’s entire asset base, including retirement accounts, such as a 401(k) and IRA, a stock portfolio and more. The goal, Balunek explains, is to build a mix of assets whose behavior doesn’t always correlate; that is, that those investments don’t always move in lock-step. That helps to level out the peaks and valleys in the overall performance of a person’s full portfolio of assets, while still producing a certain level of long-term growth. “One of the best things to do to manage risk through asset allocation is to put assets in a low-cost, high-quality, diversified stock portfolio,” she says.

    Diversification occurs across asset classes as well as within asset classes. So within the stock/equity category, a person might invest in small-cap as well as large-cap stocks, domestic as well as international, growth-oriented as well as value-oriented. The exact mix depends on the individual, their circumstances, phase of life and tolerance for risk. A person who is decades away from retirement generally may stand to tolerate more investment risk, because they have more time to recover from dips in the value of their investments. So their asset portfolio may be positioned more aggressively for growth than that of person who’s close to retiring or already there.

    1. As part of asset diversification, another important fundamental that affords investors protection from volatility is to keep a cash reserve — and be prepared to use it when the situation warrants. This is particularly important for people who are approaching retirement or already retired. Having a substantial cash reserve gives them flexibility in how and when they draw income for retirement. Say, for example, the value of an investment portfolio on which a person is relying for retirement income drops substantially. Rather than selling off stock or some other asset to generate income when the value of that asset is down, the person instead can draw income from their cash reserve while they wait for those investments to recover their value.

    A cash reserve can also provide the flexibility to pounce on ripe investment opportunities, Balunek notes. If the value of a certain company’s stock drops substantially, that may be a good time to use money in the reserve to purchase shares of that stock, while its value is down.

    1. Maintain focus on long-term investment goals and the big picture. This is about keeping the right perspective and mindset. Stock market volatility can drive people to make panic-driven, knee-jerk decisions that aren’t in their best interests. Instead of following the “Buy low, sell high” investing credo, some might panic and do the opposite, selling investments when their value has plummeted instead of waiting out the downturn and letting those investments recover in value.

    Reminding yourself of your long-term retirement strategy and goals will help keep market behavior, positive or negative, in perspective, and hopefully help you resist the urge to make unwise snap decisions about your assets.

    To reinforce those reminders, consider putting them in writing, in a formal financial plan. Having a written retirement plan in place, one to refer to when markets turn volatile, can help a person keep their financial bearings, stick to their longer-term goals and resist making ill-advised investment decisions. As tempting as it can be to look at the day-to-day, week-to-week and month-to-month movements in the value of investments, a formal financial plan can help a person stay focused on the big picture.

    As part of that plan, offers Balunek, “develop and document an investment policy that defines how the money will be used, invested and rebalanced. Before making any unplanned changes, review the policy and consider if the changes are situational or fundamental. If they are situational, evaluate other ways to meet the need before changing the investments. If they are fundamental, then revise the investment policy accordingly and implement the investment changes with the new discipline.”

    1. Build out the fixed income part of the portfolio. Generally speaking, it’s appropriate for investors to allocate some portion of their assets to fixed-return vehicles, such as bonds, regardless of their age or standing in life. Even when the stock market is down, the value of these fixed vehicles will not fluctuate.

    Here’s another fundamental that is especially important for pre-retirees and retirees. If the value of their stock investments drops, they can rely more heavily on income from fixed investments (bond funds, ladders of individual bonds, where maturity dates are staggered to continue supplying a steady stream of income), giving their stock investments time to hopefully recover. Balunek generally recommends that people start fortifying their fixed allocation five to 10 years in advance of retirement.

    June 2018 — This column is provided by the Financial Planning Association® (FPA®) of Iowa, the principal professional organization for Certified Financial PlannerTM (CFP®) professionals. FPA seeks to elevate a profession that transforms lives through the power of financial planning. Through a collaborative effort to provide more than 23,000 members with tools and resources for professional education, business support, advocacy and community, FPA is the indispensable resource for CFP® professionals. Please credit FPA of Iowa if you use this column in whole or in part.

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