What to do about increased Market Volatility?

TCI Missy

Aug 26, 2015

In talking to clients over the past week or so, we’ve heard the same comments: “Just checking in. Are things okay? Do we need to be doing anything?” Embedded in their anxiety (surely spurred on by the emphatic headlines and shouting heads of the media) are two central questions:

  1. Have markets fundamentally changed?
  2. What do I need to be doing?

Have markets fundamentally changed?

When people wonder if things are “different this time”, this is what they’re really asking. Fortunately, several volatile days strung together do not make a compelling case that the long-term outlook is any different than it was just a week ago. While we can’t anticipate the precise timing of downturns (nobody can), we do know corrections are to be reasonably expected. Since 2009, the stock market as measured by the S&P 500, has increased by more than 230% (as of last Friday) and except for a few brief times has generally marched up to new highs without much looking back. A breather is inevitable. People don’t tend to dramatically reevaluate their portfolio following a rapid increase in the market and they shouldn’t do it following a rapid drop. In fact, in the long-term view of the market, this is business as usual as you can see in this chart showing the intra-year decline versus the ending return for the calendar year.

S&P 500

Though the reason for the decline will be different every time, the likelihood of having a significant downturn in any given year is very high. Also, as we frequently emphasize, trying to time the market and avoiding the declines does not work.

A common refrain we hear is, “I’ll just get out until things cool down and then we’ll resume the plan”. Ben Casselman at fivethirtyeight.com looked at a scenario comparing a buy and hold investor to one who would “play it safe”—that is, sell any time the market lost five percent in a week, but buy back in once the market had rebounded three percent from wherever it bottomed out. With hindsight, that’s pretty effective timing. Here are the results:

Returns on Two Investing Strategies

The daily returns of the market are random and any attempt to profit off of them is a guessing game that costs you money to play through transaction costs and taxes.

Fundamental changes in the market that would force a change to TCI’s long-term outlook will occur on a much grander scale and be backed by substantial research. For example, we would need robust evidence showing small cap stocks were no longer expected to outperform large cap stocks; robust evidence showing emerging markets have lost their diversification benefits; robust evidence defining a new asset class that improves the portfolio and is investable. Common market volatility, albeit anxiety-inducing at times, does not rise to those levels.

What do I need to be doing?

This is the much more important question of the two and has a much more nuanced answer. TCI is constantly monitoring to see if market values have shifted enough to justify rebalancing.  We review portfolios for tax loss harvesting and encourage additional contributions to retirement plans and investment portfolios where appropriate. You and your advisor have planned a long term allocation that maximizes your chances of meeting your goals—both short and long-term—and it’s important that you stay near that target. The act of constant monitoring happens regardless of market conditions, but taking action becomes more likely as markets increase volatility.

Making a change to your long-term allocation should only be done if you have a change to your current situation or your goals. The one thing that’s directly related to the current volatility that may have changed for some is their willingness to take on risk. Perhaps these last few days have made you lose sleep—that’s important for your advisor to know and worth a conversation. You always have the ability to reevaluate your tolerance for risk and work with your advisor to find a solution. Of course, a change to a more conservative long-term allocation usually means one of four things:

  1. You’ll need to save more
  2. You’ll have to work longer
  3. You’ll have to spend less
  4. You’ll have less to pass on to heirs/charities/causes

An honest conversation and detailed analysis with your advisor should help quantify these tradeoffs and you may then decide that your current peace of mind is worth a change. Even in this case, however, an adjustment is being made due to a change in your circumstances (a reevaluation of your risk tolerance) and not because of a market prediction.

Remember that the media feeds off of drama. Big red numbers and stock photos of panicky traders make for a great front page after all, but rest assured that daily market swings have no relevance to your plan. In any case, TCI is here for you. We are monitoring client portfolios as we always do and our advisors are available for anyone who wants to talk. Your peace of mind and attainment of your financial goals are our priorities.

 

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