Barring an extraordinary Santa Claus rally in the last week of the year, 2018 stands to be a disappointing year for domestic and international equity markets alike. Investors have enjoyed an uncharacteristically long bull market rally that has lasted almost a decade, so the recent downward market volatility we have experienced may seem very unsettling to many investors. It is important to remember that market volatility is part of the deal for investors seeking higher investment returns. For those investors who have experienced stomach-churning moments in recent weeks because of volatile markets, here are some helpful reminders and insights about market volatility to help you better weather the storm for however long it lasts.
Keep a long-term perspective
Keeping a long-term perspective is paramount to successfully reaching and maintaining your financial goals. If you are retired, your planner at Bollin Wealth Management has placed you in an investment allocation that is commensurate with your risk tolerance and will help you reach your retirement income goals. Retirees require a balance between stability and growth in order to provide them with income today, while preserving spending power in the future. This requires a mix of stocks and bonds in their retirement portfolio. You also have an adequate cash supply on hand to help you meet your income needs for a considerable period of time: six months minimally, often times much longer. Short-term market volatility changes nothing with your plan.
If you are not retired, you are in the wealth accumulation phase of your life. If stocks were a good long-term investment vehicle for you to employ to reach your financial goals three months ago when markets were higher (as measured by the stock indices), why wouldn’t they be a good investment vehicle today when you may be able to purchase them at a five or ten percent discount?
Remember that your planner has factored market volatility into your financial plan, and your recommended investment allocation is part of that financial plan that includes your time horizon, risk tolerance, and articulated financial goals
There are two parties for every transaction
When stock markets appear to be in a free fall after an extended period of negative returns it is helpful to remember that there are two parties involved in every transaction: a seller and a buyer. For every person who panics and sells to avoid and/or limit investment losses, or for investors who feel bearish about equity markets in general, a corresponding buyer shares the opposite view and will gladly purchase the stock at a discount.
While others are selling, investors who understand the relationship between return and risk and the behavior of stock markets are snapping up stocks at bargain prices. Remember the old adage about investing: “buy low, sell high.” Investors who panic and sell during a market downturn are doing the exact opposite.
Beware of behavioral finance issues
Behavioral finance, a growing area of finance that has received a lot of attention and exploration in recent years, can inform us about behaviors and beliefs concerning investing and financial matters that prevent us from acting in our own best interests. Here are a few behavioral finance concepts to be aware of during periods of extreme market volatility.
Anchoring is the use of irrelevant information for making a financial decision, or evaluating the value of an investment. Do you think about the highest recent value of your investment portfolio when evaluating whether you are in the right investment allocation during periods of market volatility? If so, you are suffering from anchoring.
Herd behavior is mimicking the financial behaviors of the majority (herd) of people. It is helpful for me to remember the Pareto Principle, or 80/20 rule when thinking about Herd behavior. Twenty percent of the US population controls (roughly) eighty percent of the wealth. Why? It is not because there is a vast conspiracy theory to keep the masses poor. It is because the top twenty percent of wealth owners consistently make better financial decisions than the other eighty percent. If you want to maintain and grow your wealth, you need to stop thinking likes the masses and avoid Herd behavior, This includes panicking and selling off when the stock market observes a correction.
Loss aversion refers to the cognitive tendency for people to prefer avoiding losses over acquiring equivalent gains. Loss aversion is instinctively hardwired into many people’s psyche because of our heredity. Our ancient ancestors could not afford the loss of one day’s food or water supply because it might mean the difference between death and survival. On the other hand, an extra day’s supply of food or water may or may not mean an extra day of survival for our ancestors depending on their ability to effectively store the extra supply. Most humans are no longer teetering on the brink of survival on a day-to-day basis, especially as finances are concerned. Our natural bias to loss aversion needs to be managed accordingly.
It is important to be aware that there are many types of cognitive biases that can cloud our judgment about our financial affairs. Being aware of these biases can help us avoid disastrous financial mistakes. Oftentimes, talking through your concerns and questions is enough to provide investors with the peace of mind that they are doing the right things, even when newspaper headlines inspire panic in less-disciplined investors. Your financial planner at Bollin Wealth Management stands ready to help you avoid these self-inflicted financial mistakes. Be sure to call or email your financial planner when market volatility causes you consternation and concern.