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Investors recently have been reminded that markets can be volatile. So, what can an investor do to take advantage of market volatility? Here are 4 strategies to consider when markets get volatile or turn toward a “bear market.”
Make sure your investments are still aligned properly given your risk tolerance. It is common for portfolios to become more aggressive during periods of good performance as positions grow becoming a larger percentage of your overall portfolio. It is common for a moderate portfolio weighted 50% Stocks, 50% Bonds to change during strong market performance and become 70% Stocks, 30% Bonds. What was a Moderately Allocated portfolio is now Moderately Aggressive and may no longer align with your risk tolerance. Rebalancing your portfolio back to your targeted allocation given your risk tolerance is one way to minimize the impact of market volatility on your investments.
There are other questions to ask yourself to help you determine how your portfolio should be allocated like:
Has your Risk Tolerance Changed?
If yes, is your portfolio allocated appropriately for you current “risk” comfort level?
Has your time horizon changed?
As your time horizon shortens, you should consider reducing your portfolio risk level provided you can afford to do so.
Have the goals you set for your investment accounts changed?
For example, if your retirement goals have changed it stands to reason your investment strategy likely needs to change too.
Periods of negative market volatility present investment opportunities. One of the easiest ways to take advantage of lower stock and bond prices is to increase your savings during periods of heightened market volatility. Remember, the goal is to buy low and sell high. When stock and bond prices drop, you want to be a buyer and increasing your investment contribution can help you take advantage of the opportunity lower prices offer you as an investor. This strategy is commonly known as “Dollar Cost Averaging.”
Investors must try to fight the temptation to “stop” their periodic contributions during times of market stress. Our emotions tell us to stop putting money at risk by discontinuing our periodic investment plans; yet, in reality, investing through stressful times and increase periodic contributions when possible is a much better strategy.
We all have a pain threshold when it comes to how much we are willing to lose in our investments. The temptation is to sell out of investments and move that money to cash. We often fool ourselves believing we’ll reinvest the money once the market stabilizes. The reality is few of us have the discipline and conviction to reinvest the money when we should once we’ve moved to cash. Emotions often drive our decisions and we wait too long before reinvesting the money.
A way to avoid this emotional trap is to develop a reinvestment plan once you decide you’re going to move money to cash. Your plan should include the time frame you will remain in cash, how you will reinvest from cash to your chosen allocation, and over what time-period to reinvest the money moved to cash to your chosen allocation. To illustrate what I mean, Jane has a 401K valued at $200,000. She has lost $40,000 during a market correction and has reached her “pain threshold.” She moves her entire 401K to cash; but, develops a plan to stay in cash for 6 months. Starting in month 7, no matter what is happening in the market, each month she will move $20,000 from cash to her selected investment allocation. It will take 10 months to fully reinvest the cash. Meanwhile, her monthly contributions continue to invest in her chosen allocation.
In the example above, Jane doesn’t have to move 100% of her 401K to cash. She could also choose to move less than 100%. It all depends on her comfort level.
A strategy rarely employed by most investors is to remove all market risk from a percentage of their portfolio. Even Warren Buffet counsels that the percentage of your portfolio allocated to “risk off” strategies should be roughly equal to your age. For example, a 50-year old man should have roughly 50% of his portfolio allocated to “risk off” strategies.
“Risk off” strategies are typically interest-bearing strategies like Cash, Certificate of Deposits, Money Market, Fixed and Fixed Index Annuities, and, in some cases, Permanent Life Insurance. Of these strategies, Fixed and Fixed Index Annuities and Permanent Life Insurance are good considerations for money that has a longer time horizon of 5 or more years. Cash, Certificates of Deposit, and Money Market instruments are best used for shorter time horizons or for possible immediate capital needs.
Many of us haven’t forgotten the Financial Crisis of 2008-2009 and told ourselves we would be much better prepared for the next market correction. Have you developed your plan yet because we have reached new market highs, it has been almost 10 years since 2008 without a major market sell-off, the bull market for bond investors looks to be coming to an end, and market volatility has increased. Have you made any changes to your investment portfolio or developed your plan of action should things turn south?
Give these 4 strategies some thought. They can protect principal and help you take advantage of the opportunities presented in the next market correction.