Volatile markets can be unsettling for investors, but those with diversified portfolios and proper asset allocation need not be alarmed.
When your anxiety is elevated, it's a good time to check your allocation and investment strategy to ensure that they are still on track.
There are several things long-term investors can do until things settle down, but sometimes the best approach is to simply ignore near-term volatility and instead focus on long-term goals.
Economic uncertainty, political dysfunction, and unexpected "black swan" events tend to affect market stability. This can be unsettling, but investors with diversified portfolios and proper asset allocation shouldn't be alarmed. In fact, volatile markets can serve as an important reminder to check your allocation and investment strategy to ensure that they are still on track. Here, we'll take a look at the investment year to date and suggest six steps to consider when markets are unsettled.
The year to date
The Federal Reserve's near-zero interest-rate policy, low inflation, slowly falling unemployment rates, reasonable equity valuations and the housing market recovery have all helped make 2013 an exceptional year for "buy and hold" investors. The S&P 500® Index increased roughly 20% through mid-September.
However, the gains haven't been distributed equally across all market sectors. In fact, the Sector Tool in StreetSmart Edge® clearly shows that the consumer discretionary and health care sectors have significantly outperformed the utilities and materials sectors so far in 2013. As a result, there's a good chance that your portfolio allocation has shifted.
Performance by sectors
Source: StreetSmart Edge® as of October 1, 2013.
With this year-to-date information in mind, here are some practical tips you can use to help protect your holdings and stay on track for the long-term, even during periods of market volatility.
- Stay diversified. Diversification is essentially spreading your investments and your risk around. Make sure that you are diversified both within asset classes and across asset classes. As the old adage goes, "Don't put all of your eggs in one basket," the basket being a single sector, industry or even country.
Rebalancing is a way of adjusting your portfolio to keep your portfolio's risk in line with your objectives. The appreciation or depreciation of your investments could shift your allocation, and without you realizing it your portfolio could become overly concentrated in one segment of the market. This often occurs because various segments of the market perform differently at different times (as shown in the Sector Tool above). So rebalancing your portfolio periodically is important—Schwab recommends you rebalance at least every 6 or 12 months.
- Consider exchange-traded funds (ETFs) or mutual funds rather than individual stocks. ETFs and mutual funds can be a great way to diversify while avoiding the burden of selecting and buying individual stocks. Schwab offers a variety of resources, from portfolio builders to Select Lists.
- Revisit your portfolio's asset allocation. Proper asset allocation can further spread your investments around and help reduce your risk. Modern portfolio theory, which is widely used throughout the financial industry, is a method of selecting and allocating investments across various asset classes—large-cap stocks, small-cap stocks, international stocks, bonds, commodities, cash, etc. When properly allocated, your collective portfolio risk should effectively be lower than any individual portfolio asset.
Many research studies also suggest that even when portfolio assets move in tandem (more common in bear markets than bull markets), overall portfolio risk may still be reduced.1 Since stocks and bonds often react to different stimuli, a single event could cause opposite reactions. Additionally, with a properly allocated portfolio, if a single stock or bond turns sour, it will have a much smaller impact of your overall portfolio if it comprises only a small percentage of your assets.
- Take some profits off the table and maintain smaller positions. Holding on to a position larger than you're comfortable with to try and maximize gains increases your risk. If you own positions that have increased substantially in value, selling some of your shares is a good way to protect some of your gains while allowing for further upside participation, should that occur.
During times of higher than average volatility, a slightly higher cash allocation is often prudent. By taking partial profits on some of your appreciated positions and leaving those proceeds in cash, you can help protect some of your profits and lower your risk.
- Get some professional help. If you find the daily ups and downs of the market too stressful, consider letting someone else handle it for you. Many retired people find investing to be interesting and challenging. But if your regular job makes it difficult to find the time or if you'd rather spend your free time doing something else, Schwab can help. A great place to start is with a Complimentary Consultation. To find out more, give us a call at 866-849-5799.
- When in doubt, wait it out. Just as stocks can't go up forever, they also can't go down forever. Periods of heightened volatility come and go, but are generally relatively short-lived. If you don't have a good feeling for where the markets are heading, sometimes just ignoring the noise and doing nothing isn't a bad idea. Most important of all, remember that investing is a long-term endeavor; don't let short-term market volatility distract you from your long-term goals.
1. Markowitz, H.M. (1959). Portfolio Selection: Efficient Diversification of Investments.