THREE WAYS TO CALM INVESTORS’ CHURNING STOMACHS
With investors very nervous over the recent action in financial markets, I have been getting numerous calls from clients asking what they can do in order to smooth out the volatility. My first answer is to buy a bottle of Rolaids or Tums, and start popping a few of them every time you get that “feeling” in your stomach. While that may garner a chuckle, the fact is that while — intellectually — investors understand that if they are investing for the long-term there are bound to be market drops, emotionally no one likes losing money and a certain sense of panic takes over.
Here are a few tips to help you navigate these current stormy markets.
Diversify
To understand this concept more easily, we first need to define the meaning of diversification. Diversification is an investment technique that uses many varied investments within a single portfolio. The idea behind it is that a portfolio of different kinds of investments may, on average, yield higher returns and pose a lower risk than a single investment. Diversification tries to smooth out volatility in a portfolio caused by market, interest rate, currency and geopolitical risks. In laymen’s terms, don’t put all your eggs in one basket. It’s important to remember that diversification does not assure against a loss.
Unfortunately what we have seen recently and in past steep market selloffs is that just randomly owning various assets isn’t good enough. Commonly used assets to diversify a portfolio have dropped 10%-20% like stocks. If that’s the case, then there is no real point in diversifying.
According to Blackrock, “Investors have long used bonds as a way to diversify a stock portfolio — often defaulting to the typical 60% stocks and 40% bonds allocation. In the past, this strategy was generally successful, yielding a sizable return with moderate risk. During the 1990s, a 60/40 portfolio returned nearly 13% a year with volatility just over 8%. But more recently this strategy has lost much of its effectiveness, with returns of about 7% and volatility increasing above 9%. During the same time, this 60/40 portfolio had a correlation of 0.99 to a portfolio that was invested entirely in stocks.”
Low correlation
What investors need to do is look at assets that have low-correlation to the broader market — here defined as the S&P 500. The purpose of combining investments with low correlation is to provide greater diversification so that not everything in the portfolio moves in tandem. Certain market sectors that currently have low correlation are utilities, health care, consumer products and food and beverage stocks. I am not recommending that you run out and buy them, but do your own research and speak to your financial advisor to see whether she thinks they have a place in your portfolio.
Chill out
I know that it’s not easy but you need to relax and stay focused on your long-term goals. It’s important to remember that markets go up and down, and if you made a financial plan, it would have taken this type of market volatility into account. As I have written here many times, the worst thing you can do as an investor is panic and sell everything and then wait for the market to recover. The market tends to recover very quickly. Large market gains often come about in quick and unpredictable spurts, and missing just a few days of strong market returns can substantially erode long-term performance. Remember the famous investing principle of buying low and selling high. Investors who panic often end up selling low.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc. or its affiliates.
