Despite everything that went on in the world, 2021 was an easy year to be an investor.  U.S. stocks never fell more than 5.2% off their highs during the entire year, and the worst single day drop was 2.6%.  Volatility was almost non-existent, allowing investors to just sit back and watch their portfolios increase in value.  Of course, just three months into 2022, “easy” investing is in the rearview mirror. 

As of this writing, U.S. stocks have been off their high of January 3, 2022 for the entire year, with the biggest drawdown being about 12.5%.  When markets start sliding, investors often feel the urge to do something with their portfolios.  The following are some ideas to help keep your money working as best it can during volatile periods. 

If you happened to look at your portfolio when U.S. stocks were off their highs by over 12%, it can be a little daunting to see the decline in value from what you had just a month or two before.  One way to ease the pain is to step back and compare where the portfolio is valued not just to it’s high, but also compared to further back in time.  For example, while reviewing a financial plan in January of this year, an investor noticed that an investment account had grown to $500,000 as of January 3 (the market high for the S&P 500).  As shown in the chart below, a loss of 12% equates to a loss in value of about $62,500 in just over two months.  However, compared to a year ago from the 2022 low it still would have been up about 5% or worth about $20,875 more over that twelve-month period.   Three years prior to the 2022 low, the portfolio would have seen an increase of over 52%, or about $150,000 in value. 

While it can be frustrating to see a loss in value of $62,500 over a few months, reviewing just how much growth has been accomplished over a longer time frame can help put short-term losses in perspective.

While many major indices are seeing declines in value, they are not all doing so to the same degree, and some are even showing positive returns.  Of course, the most common diversifier for stocks tends to be bonds.  While some bonds are experiencing a decline in value as interest rates rise, they still offer diversification and security when compared to stocks.  For example, the Vanguard Short-Term TIPS fund, VTIP, is up about 1% for the year*. 

Diversification among equities is important as well.  A component of our clients’ asset allocations includes an allocation to the natural resources sector which has a concentration in companies involved in energy, materials, and consumer defensive sectors.  The ETF we use for this sector, ticker GUNR, is up about 14% YTD*.  Value-tilted indexes, such as the RAFI Indices are also performing comparably well to their cap-weighted counterparts, with the Fundamental Index ETFs outperforming in U.S. large, U.S. small, and international markets. 

However, being diversified isn’t necessarily enough.  To take advantage of market volatility, investors should have a rules-based strategy which forces them to sell out of the best performers – “sell high” – and buy into the underperforming asset classes – “buy low”.  Having a rebalancing strategy that is rules-based keeps investors from acting on emotion or having to predict which way markets are headed, both of which tend to be detrimental to returns. 

Risk tolerance is your ability to emotionally handle big price swings; risk capacity is your financial ability to take a loss. During extended bull markets, investors may become complacent and increase their exposure to historically more volatile investments to participate in the good returns.  While investors may want to hold off until calmer markets before making any changes to their asset allocation strategy, market downturns can be a wake-up call to reconsider your risk tolerance and if you really can handle losses, even if temporary.  Risk capacity, however, can—and should—be considered at any time. Is there enough cash to handle near-term goals? Money that is needed soon or that can’t afford to be lost shouldn't be in the stock market.  If retired, having the next 12-24 months of living expenses in cash equivalents—and a few more years’ worth in bonds can help retires stay calm when stock markets are not.

A down-trending market may provide an opportunity to see if investments are performing as expected and to possibly reduce one’s tax bill.  Index-based investments should be transparent in their holdings and performance should closely track that of the market they are indexing.  On the other hand, actively-managed funds or strategies often limit diversification, utilize leverage, or incorporate other techniques in their attempt to beat the market.  Utilizing these techniques may trigger the investments to experience even greater losses than the overall market, causing investors to realize that they don’t have the risk tolerance to stay with the strategy through downtrends. 

For investments held in taxable accounts, losses provide opportunities to tax-loss harvest and lock in capital losses.  These losses can be used to either reduce taxable income by $3,000 per year or to offset future gains.

In general, not making any major changes to your portfolio during down markets is often good advice.  However, just as during up markets, investors need to be cognizant of their investment strategy and make sure it is appropriate given their goals and take advantage of opportunities when they can.

*Returns from Yahoo Finance as of 3/24/22