3 Ways to Stay Calm When the Stock Market Gets Volatile
If the stock market were a commercial jet and investors were passengers, a lot of them would be grabbing for that little bag in their front seat pocket right about now. Whether you're already onboard or just thinking about flying the skies that haven't been so friendly lately, here are three ways to handle the rough ride. (See also: Warren Buffett's Investment Advice: Why It's So Hard to Follow)
1. Keep Your Emotions in Check
When it comes to money — and plenty of other things — the emotional extremes of fear and greed can get the best of us. But those who study behavioral finance say people are especially influenced by the fear of loss.
When the markets are headed south and the headlines contain phrases like "sell-off," "rout," and "red ink," linking those words to your future retirement or your kid's college education can make for some mighty tight knots in your stomach.
For some investors, the market's downhill slide in 2008 eventually became too much. Right about the time when stocks hit bottom in early 2009, they sold. And then they stayed on the sidelines. According to Gallup, the percentage of Americans with money in the market has fallen from a pre-recession high of 65% to about 52% today.
From their seats on the sidelines, such former investors have watched as the Dow soared from its March 9, 2009 low of 6,547 to 15,409 on May 28, 2013 — a growth rate of 135%.
While a little lightening up on equity exposure during a down market may be appropriate, it's generally best not to make any wholesale changes.
2. Understand History
According to market researcher Ibbotson Associates, between 1926 and 2010, small company stocks have grown on an average annual basis of 12.1%, large company stocks 9.9%, government bonds 5.5%, Treasury bills 3.6%, and inflation 3.0%.
While the stock market has delivered the best returns, its upward trajectory has not been without bumps, bruises, and occasional terrifying drops. That's just the nature of the beast. However, a couple of facts may help ease your queasy stomach.
You Stand to Be Corrected
A stock market correction is typically defined as a decline of around 5-15% from the market's most recent high. Between 1900 and 2010, there have been, on average, three 5% corrections per year, one 10% correction per year, and a 20% correction (technically a bear market) once every 3.5 years. This is according to Capital Research and Management Company, a market research and asset management company.
In other words, downturns are to be expected. Trying to predict when they will occur is a fool's game.
You Must Be Present to Win
According to Standard and Poor's, if you had money in the market and kept it there for the 20-year period stretching from January 1, 1993 to December 31, 2012, you would have experienced an average annual return of about 8.5%. If you had started out with $10,000, it would have grown to about $51,400.
But what if you had gotten scared during some of the bumpier times along the way and temporarily pulled your money out? If you had missed the market's five best-performing days within that 20-year period, your average annual return would have slipped to 6.3% and your balance would have tallied just $34,100. If you had missed the market's 30 best-performing days, your average annual return would have fallen all the way to .29%, barely budging your balance above your starting point — to $10,600.
3. Develop a Written Investment Plan, and Stick With It
Read a few investing blogs or the headlines of financial magazines, and you'll find it stunning just how conflicting the points of view are. One writer thinks the markets are headed higher, another is certain they'll soon take a dive. They all have their reasons.
One of the best ways to navigate the noise is to have a written investment plan. I'm not just talking about a record of what you're invested in — I'm talking about why you're investing (what goal you're pursuing); what your asset allocation is (the mix of bond- and stock-based investments you've chosen and the specific stock categories such as foreign, small-cap value, etc. you've selected) and how you arrived at those decisions (hopefully with the help of a tool that factored in your time horizon and risk tolerance); how much you need to have for certain goals such as a house down payment, retirement, or your kids' college costs; and how much you're committed to investing each month.
Your plan should include some what-if scenarios, such as what, if anything, you will do in the event of a market correction or bear market. With five or more years to invest and an appropriate asset allocation, hopefully your plan would spell out in black and white that you would stay the course during a correction. A bear market might call for some degree of reduction in stock exposure.
If you are married, your plan should be understood and agreed upon by your spouse.
No one enjoys the ride when the markets get volatile. But keeping these three points in mind may help you travel the investing journey with less anxiety.
How are you getting through the current bumpy ride?