How to Handle Stock Market Volatility

Whether it’s rough seas or a volatile stock market, the same rules apply. When storms rock the boat, don’t jump ship. Wait for the bad weather to pass and stay the course.

Recently a member of the Dough Roller Facebook group, Beverly D., asked a timely question about the stock market:

As you might imagine, her question sparked a robust conversation. So far her question has garnered 94 comments. Here’s a sample:

“That’s the problem with market timing: you have to guess right twice…” —John B.

“Good luck because no one knows.”—Mark S.

“Most people are predicting it will go even lower. The earning report is not looking good. We are looking like we are going into a recession now. I have not personally pulled out any money but I have money waited for when it goes lower to invest.”—Sara S.

Here was my answer: “9-24-18.”

In this article I’m going to look at this issue in more depth. How exactly should we handle market volatility? And whatever our answer is to that question, how do we actually do it? How do we overcome our emotions?

Overview of Stock Market Performance

Let’s start by looking at what happened in the market (S&P 500) over the past several months. The S&P 500 index was down about -6.24% in 2018, according to Morningstar. That number, however, doesn’t tell the whole story.

When we look at the quarterly returns of the S&P 500 in 2018, we see a painful Q4:

• Q1: -1.22%
• Q2: 2.93%
• Q3: 7.20%
• Q4: -13.97%

Because Beverly “jumped ship” at the end of September, she managed to avoid a lot of pain.

So far in 2019, things have been a bit better. As I type these words on January 24th, the index is up 5.19% YTD. I don’t know if Beverly has reinvested in the market. Even if she hasn’t however, she’s still better off having been on the sidelines that last few months.

Stories like Beverly’s present a conundrum. On the one hand we’d all like to avoid the pain of a down market. On the other hand, how likely is it that we will repeatedly get as lucky as Beverly appears to have been? Not only must we guess right when getting out of the market. We have to guess right about when to get back in. And we have to do this over and over and over again for a lifetime of investing.

We probably have a better shot at winning the Powerball lottery, twice.

Review of Studies on Timing the Market

Studies show that market timing is not a reliable way to improve investment returns. One fascinating study looked at Target Date Funds (TDF) common in 401(k) retirement accounts.

A TDF will slowly shift its asset allocation away from stocks toward bonds as workers near retirement. Some TDF managers, however, alter this “glide path,” as it’s called, in an effort to boost returns by timing the market. Keep in mind these are highly educated, trained investment advisors.

So how did they do? Not so good. According to the study by the Center for Retirement Research at Boston College, TDFs that timed the market reduced their returns by -11.5 basis points per year. When they focused on TDFs with a longer tracker record, the results got even worse, -14.1 basis points.

Why Staying in the Market is Difficult for Some

We know that timing the market is a bad bet. We know that all of the returns data showing how well we’ll do over the long-term assume we stay in the market. Yet some of us just can’t seem to help it. Why?

I think there are two answers: fear and greed.

Fear is an obvious explanation. It’s scary to watch your nest egg go down by 10, 20, or even 40% in a short period of time. It’s even worse if you are nearing retirement.

Further, when the market is down significantly, there are other things in the world going haywire as well. In 2008-09 we had the housing crises, banking crises, and rising unemployment. In the 4th quarter of last year, we had trade wars, a partial government shutdown, and a horrible non-call in the Rams vs. Saints game (ok, this probably didn’t affect the markets, but it was bad, real bad).

The point is that bad markets usually come with other scary things. As the bad news mounts, it’s easy to understand why some people cash out.

Greed, and it’s distant cousin, the fear of missing out, also cause some to time the market. It’s understandable for some to get tired of hearing how their friends and co-workers are killing it in the market. If they are invested heavily in bonds while the stock market parties like it’s 1999, eventually they can’t take it anymore. And they tend to get into the market at the worst time–just as it nears its zenith.

The news doesn’t help. News outlets love to publish stories about financial “experts” with predictions about future markets. These stories often start out like this–“Mr. Expert, who correctly predicted the [fill in a past financial calamity] says the stock market will [go up, go down, move sideways, do a cartwheel].”

Just for kicks, I Googled the following: “Stock market predictions 2019″

Here’s a sampling of what I found:

• USA Today: Dow outlook: Why I’m optimistic about the stock market for 2019
• Money: A Rough Road: 5 Investing Pros Predict Where the Stock Market is Headed in 2019
• NY Times: This Expert Called the Market Plunge. Here’s What He Sees in 2019

If we’re not careful, we may confuse these and similar stories as containing something of value.

Tips on Staying the Course

I hope I’ve convinced you that timing the market is a fool’s errand. Even if I have, you may still be wondering how you can stick to your investment plan in all markets. Here’s how I do it.

1. Invest primarily in index funds: We talk a lot about the value of index funds due to their low costs and superior performance. There’s another reason I favor index funds. I don’t have to worry about a fund manager making a mistake. When an actively managed fund goes down, it may be because of the market. It may be because the manager has made a horrible mistake. With index funds, I don’t have to concern myself with human error.
2. Study stock market history: A look back over the past 100 years is revealing. We’ve lived through some difficult times. From world wars to depressions to 9/11. They are painful. But we pull through. We get back up. We keep going. So does the stock market.
3. Never invest money you’ll need in the next five years: The stock market, like any investment in a business, is a long-term adventure. You shouldn’t put money in equities that you may need in the next five years. Make it ten years if that makes you more comfortable, particularly in retirement.
4. Keep your debt to a minimum: This doesn’t get much attention in terms of investing, but it’s important. I’ve found it much easier to stomach falling markets when my debt was manageable.
5. Don’t check your investments routinely: When the market is down, I often go days or weeks without looking at my balances. Some people I know go months without looking, which is even better.
6. Rebalance regularly: Rebalancing a portfolio is important to maintain your desired asset allocation. Once a year is more than enough. I find Personal Capital to be an excellent tool for understanding how your asset allocation has shifted over time.

Remember, when you embark on your investment journey, you are the captain of your own ship. It’s important to learn how to navigate through the storms as smoothly as you sail through the calm seas. Bon voyage!

Topics: Investing

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