A “do nothing” prescription might be tough to swallow if you’ve been caught off-guard by recent volatility. But Mr. McNabb points out that no action is an active decision, and can be the right decision for reaching long-term financial goals.
Here are a few simple rules to help you through the current feverish reaction.
The key to getting through unexpected turbulence is to understand that swings in the financial market are normal—and relatively insignificant over the long haul. The best approach to protect portfolios is to diversify among a broad mix of global stocks and high-quality bonds so that you are better poised to buffer the declines in the equity market.
Rule #1: Recognize that volatility and periodic corrections are common in equity markets.
Year-to-date, the S&P 500 Index is down about three percentage points and down slightly on a year-over-year basis.1 Since the bottom of the global financial crisis in 2009, the index had enjoyed the second-largest bull market in U.S. history—an extraordinary run that may help put current concerns in perspective.
“We’re coming off an extremely placid period in markets. So the recent spike in volatility is going to feel a lot worse,”
Seeing the same story at the top of every news site you visit, as well as seeing related portfolio fluctuations, is likely to worry you more than it should.
Rule #2: Tune out the noise, and remove emotion from investing.
If you’re a long-term investor, resist the urge to make drastic changes to your investment plans in reaction to market moves. You may find what’s driving the overreaction in markets is nothing more than speculation.
Making shifts to your portfolio in hopes of avoiding a loss or finding a gain rarely works long-term. Investors who panicked and dumped stock holdings in 2008 and 2009, believing they could get back in when “the coast was clear,” likely suffered equity losses without the benefit of fully participating in the recovery. Vanguard research finds that a buy-and-hold approach outperformed a performance-chasing strategy by 2.8% per year on average during the 10-year period analyzed.
Also, try not to look at your accounts every day. It’s unnecessary and may do more harm than good. Remember that portfolio changes, aside from routine rebalancing, can result in significant capital gains if you sell after a big market run-up, possibly even if conditions have changed. And don’t forget you need to know when to jump out of the market and then get back in—decisions few investors can and should tackle.
Save more, and continue to invest regularly. Boosting savings is important to your long-term financial goals. We believe market returns will be muted over the next few years; therefore, stick to your investing principles and avoid getting caught up in the market.
Rule #3: Make volatility work for you.
If you invest regularly through payroll deduction, an automatic investment plan, or a target-date fund, you’re putting the market’s natural volatility to work for you. Continue making contributions to take advantage of dollar-cost averaging. Buying a fixed dollar amount on a regular schedule offers opportunities to buy low during market dips. Over time, regular contributions can help reduce the average price you pay for your fund shares.2
If your portfolio is broadly diversified and has the appropriate balance for your financial goals, time horizon, and risk comfort level, sticking with it is a wise move.
The inaction plan
“Because no one knows what the future holds, a globally diversified strategy can be more advantageous than shifting too much in any direction,” says Mr. McNabb. “You can resist the temptation and save yourself the stress by tuning out the noise. It’s okay to ignore volatility—that’s part of the plan.”
1 Performance calculation is based on S&P 500 values (2058.90 on 12/31/14; 1970.89 on 8/21/15; 1992.37 on 8/21/14; 676.53 on 3/9/09).
2 Dollar-cost averaging does not guarantee that your investments will make a profit, nor does it protect you against losses when stock or bond prices are falling. You should consider whether you would be willing to continue investing during a long downturn in the market, because dollar-cost averaging involves making continuous investments regardless of fluctuating price levels.
All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.