Does the thought of a 10% stock market drop make your stomach drop?
Maybe you recall the jitters and anxiety when the last crash came through, and you watched the value of your investments fall… and fall… and keep falling.
Unfortunately, you can expect sharp drops in the stock market at any time. Today, tomorrow, next week. It can happen suddenly and without warning.
Even within recent memory, there was the dot-com boom-and-bust, and the Great Recession of 2008-2009, where the stock market lost 48% of its value from peak to trough.1 Those who fared the worst were the ones who sold their stocks as the market kept falling and realized their losses.
Watching the markets ebb and flow is like being a surfer watching the waves.
Surfers don’t have the opportunity to do much when the water’s smooth or barely rippling. The fun doesn’t start until the monstrous waves start crashing.
To a passerby, the waves look scary and dangerous. But to a surfer, all they see is opportunity.
Just like surfing, in the stock market opportunity comes with fluctuations in the underlying environment.
Surfers know that a big wave can mean a tremendous and awe-inspiring ride, but it can also mean a big wipeout.
In the stock market, there are typically three reactions, as there are to any kind of potentially bad news: fight, flight, or freeze. Sometimes doing nothing (or freezing) is the right thing to do.
Of course, the trick is knowing which one is best for your personal situation! Unfortunately, it’s all too easy to take the wrong lessons from past recessions and market pullbacks, leaving you unprepared for a big wave when the next one hits.
Knowing how to take those rides through rough and smooth will help you not only potentially build more wealth, but potentially lose less when the inevitable dips, recessions, and pullbacks occur.
Just as waves are crucial to surfing, volatility is a feature of the market, not a bug.
Given that no one knows when the next drawdown could occur, are you confident that you’ll be able to ride it out without losing your money … or your mind?
This sensible strategy guide is designed for people who invest in the stock market — just like you — and want to make smart decisions about their money, no matter what’s happening in the financial sector. It will help you master the waves of volatility so you can take advantage of the opportunities that come your way when the ride gets rough.
You’re probably asking yourself questions like:
- What happens to my money when the stock market takes a dip?
- Will I need to make changes to my lifestyle when there’s a drawdown in the market?
- Do I know when to stay put and when to flee or fight in different market situations?
- Are my investments properly situated for the next market movement?
- Do I have a financial professional who stays in touch with me to guide me even when things look bleak?
If any of these struck a chord with you, keep reading…
Ride the Rollers Technique #1: Know when to hang on so you don’t drown
Know when to hang on so you don’t drown.
Sometimes the swells and dips are barely a ripple in the water, and there’s no advantage in trying to surf them. Just hold on and wait them out. Even when the fluctuations get bigger, you don’t necessarily need to change your course and adjust your portfolio. Staying invested and riding out the fluctuations is often the right way to handle volatility in the market.
Your investment losses are only on paper … unless you actually sell the investments. That’s a mistake many investors (who weren’t connected to a knowledgeable professional) made in the Great Recession.
As you know, the key to building wealth is to buy low and sell high. When you allow the emotions you’re experiencing to get the better of you, you can end up buying high and selling low. Preventing your emotions from overriding your logical brain is a crucial component to holding on when you need to.
Vital questions you need to ask include:
- Have I dialed in my risk tolerance correctly?
- Am I aware of the situations that require me to freeze, or do nothing, to my portfolio?
- Do I have the stamina to ride out market volatility without becoming too emotional?
- Is my portfolio positioned to take advantage of market upturns?
- Do I have access to a financial professional who can help me hang on when it’s necessary?
Ride the Rollers Technique #2: Know how to balance your risk tolerance
Some investors are naturally aggressive and don’t mind taking on paper losses as long as they do well when the market does well. Others are more concerned with protecting themselves against too much loss when there’s a slump or worse.
Risk is the flip side of the coin from reward. By overprotecting your portfolio from volatility, you won’t have enough purchasing power later on in life. While Americans spent a few years not experiencing much inflation, 2021 brought a sudden 6.2% uptick in prices — that was the highest spike in decades.2
While cash provides protection against stock volatility, it actually loses ground to inflation: your purchasing power gradually ebbs as consumer prices trend higher. And when interest rates are low, bonds don’t help fight inflation much either.
In other words, you do need some exposure to the stock market throughout your lifetime — yes, that includes after retirement — in order to help maintain the purchasing power of your money.
On the other hand, you need to be able to tolerate market downturns without becoming so fearful that you end up selling in a downturn, which permanently reduces your purchasing power.
The right portfolio for you is the one that doesn’t result in losing sleep when the market’s in a trough but still allows you to potentially profit when it’s peaking.
Vital questions you need to ask include:
- How easily could I tolerate a significant loss on paper in my investments?
- Do I have enough money positioned to take advantage of market growth?
- Have I made sure I can maintain my purchasing power after retirement?
- Do I have a financial professional who can help me balance my need for safety and the need for growth?
Ride the Rollers Technique #3: Know when to skip the surf
Smart money makers are also tuned in to their capacity for risk. What’s your timeline for needing the money that you’re currently investing? If it’s decades from now, you can afford to ride out the inevitable recessions and downturns in the market. Over the long term, the stock market returns an average of about 9% annually, though the past can’t predict the future.3
By contrast, when you’re closer to retirement, the last thing you want to do is have all your money in the market. If there’s a downturn when you need the funds, you’ll need to sell something to generate income. That’s when paper losses become real. As you approach your withdrawal date, you’ll need some funds that won’t be subject to a stock market pullback.
Depending on your timeframe, you may need to adjust your portfolio to provide calmer seas for some of your money. You won’t need all of your money at the beginning of retirement because you’re likely to live at least another decade or two. So you can’t remove your portfolio from the surf completely.
Whether you’re naturally risk-averse or risk tolerant, it’s critical that your portfolio is positioned for your personal situation.
Vital questions you need to ask include:
- Is my portfolio calibrated to my stage in life?
- Are my investments well-positioned to carry me to retirement and beyond?
- Will I need to sell investments to generate income in the next few years?
- Do I have a financial professional who can help make sure my portfolio can withstand years of volatility?
Keep Calm & Help Your Portfolio Thrive In Rough Waters
You’ve been successful with your stock market investing while it’s rippling gently, but you may be concerned about whether you can stay afloat when the big breakers start ripping through.
Having the wisdom to know the difference between when to flee and when to freeze is critical in building portfolios that will survive the inevitable volatility in the market. You know that breakers are a natural part of the experience and that often the right thing to do is stay invested. Otherwise, making adjustments could potentially transform paper losses into real ones.
Fortunately, it’s possible to build a portfolio of investments that benefit from the growth of the market — whenever and wherever it happens — and also potentially set aside a portion that’s untouched by stock market volatility, so that you can sleep at night.
While you may already have a portion of your portfolio that protects you from price fluctuations, you may need to adjust it, depending on your ability to deal with risk. Without enough stock market exposure, you may not reap the kind of rewards that can potentially help you stay on top of inflation and help ensure that you have purchasing power in the years to come.
Unfortunately, no one’s got a crystal ball to spot the next crash coming. Since stock markets have been swelling pretty consistently since 2009, the next trough is likely not far away. Making any necessary adjustments as soon as possible could be what prevents you from wiping out when the next big one comes through.
Our team has the knowledge and experience to help people with money in the market just like you to craft a portfolio that is right for your situation.
Perhaps even more critically, we’re there for our clients when the big waves start hitting the market. We won’t leave you to figure out your strategy alone.
It’s crucial to make sure that you’re properly positioned to take advantage of the potential benefits of investing, no matter how big the volatility gets. You need a team of professionals who can help guide you through the fluctuations, and remain at your side when the going gets rough.
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Article written by Peter Kim, CFP® on March 15, 2022