Stay the course in volatile markets
by Don Kuehn
Boy, talk about volatility. The past few months have seen some of the wildest swings in the stock markets since, well, ever. Gains and losses of 200 to 300 hundred points have been commonplace, triggered not so much by the performance of U.S. companies or their expected earnings per share (the catalysts that cause stock prices to go up or down in normal times), but by events beyond our borders.
Wars and the economies they breed would normally be a boost for industrial companies. (Remember President Eisenhower's warning about the military-industrial complex in his 1961farewell speech? Of course you don't— you're not old enough—but maybe you've read about it?)
Economic optimism (or pessimism) typically drives people to invest in certain companies or sectors of the market that seem poised to benefit from popular sentiment. New innovations or product lines can be a reason to buy a company stock. Even market trends can be a clue about whether to buy or sell.
But the financial health of some of our trading partners in the European Union (the threat of national insolvency in Greece, for example); the EU decisions of whether to bail out foundering national governments; and other international events like the earthquake/tsunami in Japan have caused a fragile U.S. market to buck wildly in 100- point swings that haven't been seen with this regularity before.
If you are a passive observer of Wall Street news, you probably wonder what the heck is going on. Why would anyone put their hard-earned money at such risk? Call me if the markets ever settle back down to a more comfortable level.
At times like these, it is good to remember the old axiom: Buy low, sell high.
I know, it's not a new or novel idea, and if it were easy, everybody would be doing it. But individuals and professional money managers alike are susceptible to jumping on—and off—the bandwagon when national or world events create turmoil in the markets.
For professionals, it's one thing. Their sophisticated, computerized market-timing strategies can produce small profits from even the tiniest swings in stock prices— if they're right. But you and I are not that sophisticated ... or lucky. The best tools we have are discipline and good sense, measurable time horizons and adequate time to make sound decisions about when and where we are going to invest our money.
We all have a certain aversion to risk. Nobody likes to lose money. But acting impulsively when news of sudden market fluctuations hits, more often than not, leads to actions that turn out to be regrettable in hindsight. Here are some statistics provided by Fidelity Investments:
During the tumultuous 18-month period from October 2008 to March 2010, when the Dow Jones Industrial Average dropped from 14,000-plus to under 7,000 and then climbed back to about 11,000 (a gut-wrenching roller coaster ride if there ever was one), most people in workplace retirement savings plans—like 401(k) plans—stayed on course.
Some of those investors might have been too distracted by other events in their lives, may have been numb to what was happening to their accounts, or may not have known how to manage their assets and, therefore, just left them alone. But for whatever reason, they kept on track during a period of significant turmoil.
This cohort of more than 7 million investors who continued to invest regularly, didn't panic and rode out the markets' swings, saw a positive gain of 21.8 percent in their account balances at the end of the period.
Contrast them with a group of 81,400 participants who did panic. When the going got tough, they got going—sold all of their stock holdings and stopped investing completely during the period reducing their exposure in equities (stocks) to zero. They saw the value of their portfolios drop by 6.8 percent. That's a whopping 28.6 percent difference compared with their brethren who stayed the course (almost four years' worth of "normal" annual gains).
Fidelity reviewed a third group of 51,400 investors who panicked at first and sold all stocks, but jumped back in at some time before the end of the survey period. These investors saw an increase in their portfolios of 6.1 percent. Not too bad, but still way below what the first group did.
The fine print: Changes in account balances in the study reflected both employee and employer contributions, as well as loans and withdrawals and market activity. Of course, this study looked at a specific time period with a clear beginning and end. What might happen during other times of market fluctuation in the future could be different.
The message is clear to me. It pays to keep doing what you normally would do even when the markets scare the devil out of you. When the Dow or the S&P 500 drops like a rock, it means good companies, whose stock prices have been punished for no apparent reason, are on sale! And who doesn't like a good sale nowadays? Remember: Buy low.
I have discussed the theory of dollar-cost averaging in this column before. The idea is that you continue to invest a set amount at regular intervals, be it monthly, quarterly or every other week. By doing so, you buy more shares with your money when prices are low and fewer shares when prices are high.
Spreading out the cost of your holdings like this does two things: It forces you to be disciplined and consistent, and it keeps you investing when you might otherwise be tempted to bail out. Some studies have shown that consistency is a better predictor of successful investing than the choices you make about what to invest in.
Is investing in stocks or—as I constantly preach here—in stock mutual funds, risky? You bet it is. But with that risk comes the potential for rewards. Fortunately, there are many good, low-cost no-load mutual funds on the market that make it possible to find appropriate places to stash your cash and balance that risk. You should be able to find one or more that fit your comfort level with a little research and some time.
Becoming an educated investor is key. There's a lot that factors into your investment decisions, such as your risk tolerance, your goals and time horizons, other obligations you have and whether you are investing in a tax-advantaged plan or a company-match plan. You also may want to favor more conservative assets such as dividend-paying stock funds, balanced funds, target-date funds or high-grade corporate bond funds as alternatives to more volatile large company growth funds.
But again, it's not so much what you invest in (as long as you know why you bought it and are comfortable with your choice) but that you stay an active investor through good times and bad that matters most.
Unless you plan on inheriting huge sums of cash or have some other magic up your sleeve, the only way to leverage small amounts of disposable income into a large nest egg to fund retirement, or any other goal you have in life, is to accept the inherent risk of investing in the stock and bond markets. And for just about every investor, no-load mutual funds are the best place to get started.
While the markets have weathered many storms, new ones are bound to blow in and create more instability. It's your money. Long-term discipline is the best way for you to counterbalance the short-term gyrations that are sure to rock the markets.
Don Kuehn is a retired AFT senior national representative. For specific advice relative to your personal situation, consult competent legal, tax or financial counsel. Comments and questions can be sent to email@example.com.