6/30/17

Before we proceed, let’s get two things straight: First, there is no such thing as a “correction”. When buyers and sellers agree on a price, that is the correct market price. However, there have been and will be large market price declines. Second, no one, ourselves included, has any reliable way of forecasting the next large decline. Predicting a large decline is a near-impossible feat that is further muddled by endless predictions among investors in the media about when the market will decline and what will cause it. The important question is: are you prepared to handle a large decline if and when it occurs?

Just as with any emotional experience the future may hold, it’s valuable to walk through the scenario in the calm of the present so you’re better prepared to behave properly in the emotional throes of the actual experience. This is true for everything from fire drills to wedding rehearsals. You have a far greater chance of sticking to the plan if you’ve practiced it a few times beforehand. Seems pretty logical, right?

Is Market Volatility on the Horizon?

Although no one can accurately predict precisely when a market will take a turn, market volatility is inevitable at one point or another.

According to the CBOE Volatility Index (VIX), which gauges how confident investors are in the market remaining stable, investors remain relatively calm about their prospects of a smooth market in the near-term. According to the most recent VIX, investors are 6 times more confident in the market’s stability than a decade ago.

Despite this confidence in the markets, investors are exposed to anecdotal stories and interpretations that provoke fear and concern about market volatility on a near daily basis. Sources of this fear range from geopolitical events to cyclical timing to other economic indicators – any of which can be interpreted in myriad ways.

What to Do During Periods of Market Volatility

In Warren Buffett’s recent letter to Berkshire Hathaway shareholders, the multi-billionaire investor gave advice to investors on how to react during market downturns and volatility. His core message to investors? Stay calm.

“During such scary periods, you should never forget two things,” he said. “First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy.”

So, what does “staying calm” look like in action?

First, if you have implemented a balanced, long-term strategy for your portfolio, it is important to avoid the emotional trap of making sudden, reactionary shifts in response to near-term forecasts or perceived volatility. Instead, remain secure and steadfast in your long-term portfolio strategy. Market volatility can certainly provide you with an opportunity to revisit your portfolio allocation, but make sure any changes made to your portfolio are made with your long-term goals in mind.

Second, capitalize on market volatility. As Buffett claims, “widespread fear is your friend”. Buffett suggests that some of the best deals and returns are delivered in the immediate aftermath of a market downturn, but only if you remain calm and vigilant. Instead of panicking and fleeing the market, look for bargain buying opportunities during periods of unrest by following a disciplined rebalancing strategy.

Finally, revisit the key pillars of your portfolio in a holistic way. Once the storms have passed, re-assess these factors to determine if you were comfortable with your level of risk, balance of holdings, and felt that your portfolio continued to reflect your long-term financial goals should another period of volatility occur.

The greatest evidence to support a steadfast, long-term portfolio allocation is by reflecting on the financial crisis in 2008. Despite significant short-term losses during the crisis, those with balanced portfolios who remained disciplined and faithful to their long-term investment plan in 2007-2008 would have likely recouped their losses within just a few years. In fact, the S&P 500 Index is up 291% from the bottom of the crisis (March 1, 2009) through the end of last month (May 31, 2017).

To close, it’s imperative to stay focused on the goal of building and executing a plan to withstand market downturns and resist the siren song of trying to avoid them. Despite relatively smooth sailing for the time being, there is never a better time than today to ensure you are well-prepared, both functionally and emotionally, for tomorrow.

 

The FMB Blog

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