All investment markets, including stocks, bonds, real estate and commodities, experience price and total return volatility. In the last few months, volatility has increased in markets due to global economic and political conditions.
This is part of a long-term trend that has seen volatility increase in all markets over the last 15 years. For longer term investors, not traders, this leads to higher risks in all types of investments.
What can an individual investor do to keep their portfolio in line with their goals? You can choose to stay out of the market, avoiding the risks but also any benefits. You can find ways to recognize and deal with the risks so you can get some of the benefits and reduce the potential for losses. You can insure your investments against loss. Investment insurance is a complex discussion so I'll leave that for another time.
Here are seven things you can do now to deal with market swings:
Take the big picture view
Look at your overall portfolio performance and value change. Recognize investing is a long-term activity that involves ups and downs. Be disciplined and focus on the longer term trend of your portfolio. Don't obsess about the short-term movements. Focusing only on the investments that are experiencing short-term swings and mak
ing changes can destroy your game plan.
Long-term strategic plan
To implement the first item, you must first have a plan. Your plan must include not only your desired returns, but the risks you are willing to take. This is paramount to successfully sticking with your plan. Choose your investments carefully so you can stick with your plan through the upsets that will inevitably occur. Diversification, done properly, will help reduce your portfolio volatility by offsetting different investment risks.
Short-term tactical plan
No matter how much strategic planning you do, market upsets affect everyone as they think about their money. You need a "what if" plan to back you up. By predetermining how you will react if an event occurs, will help you make rational decisions. For example, you might sell, or buy, an investment when volatility has reached a threshold. This allows you to lock in gains, cut your losses or position yourself for future gains.
The key is to set up the parameters when markets are calm and make sure the actions support your long-term plan. Remember that it doesn't have to be all or nothing. The wise move might be to take your profits in cash, holding them for a better opportunity, and let your original investment ride.
Use other investors' emotions to your benefit
Investing is not just a numbers game. If you have yours under control, you can be a contrarian to market sentiment. When others are nervous and selling, you can purchase investments that fit your portfolio at lower prices. Because you are buying them for the long-term benefits, you can be less concerned about short-term swings. Knowing what you want to do before emotions take over makes a difference in ability to stay on track and succeed.
Know why you own
Remembering why you bought an investment helps when making a sell decision. If it is not living up to its role in your portfolio, doesn't fit your goals or risk profile, then it is time to make a change.
By occasionally rebalancing to your target mix, you keep your risk level in line with your original plan. If your goals and risk profile have not changed, you want your investment risk level to be the same. There have been many studies on when to rebalance. For simplicity, rebalancing once a year or when the allocation is over 5 percent from your target lets you capture a majority of the benefits.
Let cash steady your hand
Having cash can moderate the volatility in your portfolio. Knowing that you have something to fall back on can be a great comfort. If not being fully invested, holding some cash, lets you stick with your investment plan, it is well worth the lower return on cash.
Almost everything you can do to handle market swings is best put into place before events occur. This is similar to insurance, which is very expensive or impossible to get when an event is imminent. Taking some time now, to plan for future possibilities, can improve your investment results and reduce anxiety.
Tom Roberts, a certified financial planner and owner of A New Approach Financial Planning in Lakewood Ranch and Sarasota, can be reached at 941-927-9590 or Tom@ANewApproachFP.com.