Thoughtful Investors Should Respond to Fluctuations With a Clinical Approach
Unlike two years ago, when in January 2016, we saw the largest start-of-year decline in the history of the S&P 500, this year, stocks soared out of the gate. It appeared good times would roll on. That changed abruptly a few weeks ago, and investors are left wondering, “What should we do now?”
Before providing a specific recommendation for how we believe every thoughtful investor should respond, allow us to address two important points.
The downdraft we saw at the beginning of February was especially challenging for many because of its speed (one of the quickest declines of 10% we’ve ever seen) and the fact that it followed one of the calmest years in the history of stocks (no declines of greater than 2% in the S&P 500 last year).
While only time will tell if this decline is constructive or instead leads to a bona-fide bear market and real pain, we feel it’s more likely this was a healthy sell-off. We base this on the fact that this correction wasn’t triggered by fears of a recession, but interestingly just the opposite. This swift move lower was the result of accelerating growth, leading to higher interest rates, which is potential competition for stocks. We’re also encouraged that we didn’t see indiscriminate selling of risk assets; but rather, the more overvalued areas of the market were punished most.
A Clinical Approach
So back to how investors can thoughtfully respond to this changed environment. Given that no one can predict with certainty how stocks (or bonds for that matter) will perform, we strongly advocate adopting a clinical approach.
1. Re-assess your risk/return profile. Simply put, do you truly need to take on the added risk that accompanies higher expected returns from your current allocation? Consider it a luxury to ponder this question with markets at these levels.
2. Adjust any of your Three Levers as necessary. Remember that all Three Levers – Inflows, Outflows and Expected Return – might deliver your solution. If you can’t bear the thought of your portfolio dropping, say, 20 percent, consider modifying inflows (e.g., Can you save more?) or delaying/reducing/eliminating outflows (e.g., distributions from your portfolio).
3. Thoughtfully diversify. Even with recent declines, very few asset classes appear to have cheap valuations. As a result, broad diversification remains a necessity. But that doesn’t mean sitting on bundles of cash. Remember, there’s no guarantee stocks will falter, and trying to time the market is often a loser’s game.
4. Thoughtfully rebalance. Adopting a disciplined approach to selling winners and reinvesting according to a long-term plan makes perfect sense and becomes particularly important in volatile markets.
5. Be disciplined when things get rough. The return of volatility can be unsettling, so it won’t shock us if investors react poorly. But by following a clinical approach, you will have affirmed your objectives and why your portfolio is positioned as it is. Knowledge truly can be power – and you’ll have it. It’s also helpful to appreciate that the typical bear market lasts less than 18 months.