Best Practices for Volatile Markets

After a volatile six month period for the market, investors may be a little concerned and surprised by the daily ups and downs. After all, bear markets have been in hibernation since 2009 and volatility has been low since the 2011 U.S. budget crisis. Now that bear markets have emerged in many parts of the world and U.S. stock prices are declining, investors may need a helping hand with best practices for navigating volatile markets.

Recent Market Declines

Price declines and volatility are the only things rising in today’s stock markets. From August 2015 to January 2016, the U.S. stock market (S&P 500) has gone through eight swings of 5% or more - down (Aug-Sep), up (Oct-Nov), down (Dec-Jan). During this period, stocks declined about 7%.

Unfortunately, the current sell-off in large U.S. stocks is relatively small compared to the rest of the world. To illustrate, let’s start with an investment’s highest price over the last year. From this high point, what is the price decline through today (February 2nd, 2016)? For large U.S. stocks, the decline is about 11%. While this decline sounds, large, it is actually normal (more on this later). Investors may be surprised to hear that the majority of world’s stock markets are already in bear markets. A bear market is defined as a price decline of 20% or more. This list includes many asset classes such as small U.S., energy/natural resources, emerging markets, pacific region, and Europe. While global diversification is helpful over the long-term, it has not benefited investors over the last year.

Stock Market Principles

Like most things in life, investing is a double-edged sword. Stocks offer the long-term benefit of growing wealth above the rate of inflation. Their cost is intermediate term price swings and an unknown future value. You cannot have one without the other. In addition to these two principles of investing, there are a few other market behaviors investors should keep in mind.

• Stock prices have declined by 14% at some point during a year on average
• Bear markets have occurred once every 5 years with price declines of 30% on average
• Stocks have outperformed bonds 85% of the time over 10 year periods
• Stocks have returned about 10% per year on average over 20 year periods

Best Practices for Today’s Market

So what are some best practices for today’s volatile market?

1. Start by understanding the basic principles and behaviors of the market. Some of the most dangerous words in investing are “this time is different”. Stocks have experienced incredible swings in the past, but have provided real returns to patient investors. Misunderstanding the rules, setting expectations too high, or thinking “this time is different” are ways investors can run into trouble.

2. Prepare. Having a written set of rules to follow are essential for most important activities in life, especially investing. The plan can be simple, but it should not be delayed until after the spring break vacation itinerary is completed.

3. Once the rules are in place, you need to follow-through. This is where even the most seasoned investor can fall short - actually doing what they said they would do. There is usually some reason NOT to follow-through - work, family, sleep, “this time is different”. If there is no follow-through, long-term success will depend on luck.

With these ideas in mind, try not to let the short-term market swings distract you from what is really important and within your control - your goals, plan, and follow-through. If we can help you with reviewing your plan and investment process, please let us know.