Have you ever listened to the news, or someone advising you to buy or sell an asset based on current market conditions? Reacting irrationally to major news or disruptions in the economy can create volatility that can have a significant impact on your net worth. Sometimes it’s good to take a step back and wait until the market volatility has passed and make a decision that aligns with your investment goals and strategy. We will discuss strategies on how to avoid market volatility, a few of the strategies we will discuss are investing regularly, diversifying across different asset classes, and having a long-term mindset. “The market” will be referred to any market you can buy or sell an asset class.
Cost Average Investing
All investors ask a similar question, “Is now a good time to enter the market?”. But this question cannot be answered with a simple yes or no. The best answer is that it depends on your personal situation and factors like time horizon, tax implications, etc. One strategy for long term investing is called cost average investing. Timing the market is not something that even the greatest investors can do or try and do. Therefore, regardless if the market is up or down, buying index funds, stocks, investment properties, bonds, and so on can average your overall cost basis over your investing life smoothing out the highs and lows of different markets. When buying over a long period of time you know you are not making irrational decisions based on short term trends. That is why time in the market is better than timing the market.
Diversifying
Another tip is diversifying your portfolio, diversification over the long term, in different asset classes, can help build net worth over time while reducing risk. For example, the stock market has many individual stocks whose performance can vary significantly depending on the industry they are in, their location, and regulatory requirements. An example would be, if the technology sector has had significant increases while the banking sector has significantly lagged the technology sector and a investor started buying the red hot technology sector chasing it higher. Then months later the sector became stagnant and started retracing from its highs. Industrials and consumer cyclicals could start to look attractive for investors and now those sectors are reaching higher highs. Well, if you allocated your portfolio to the broader market, you could balance out the retracement of the technology sector and gain from the increase of the industrial and consumer cyclical sectors, “balancing” your stock portfolio.
The stock market isn’t the only way to invest. There are other ways to diversify through bonds, real estate, and other investments. In the 1980’s when interest rates were 10-16% on the 10-year treasury having a percentage of your portfolio in bonds was great because your portfolio would earn interest at a higher rate, while returns in the stock market lagged.
Having a short-term investing mindset and trying to time the market can lead to significant losses. Cost average investing, which was discussed above, over the long-term can help avoid some risk of losing your money. Long-term investing also has tax advantages, you would be taxed at 0%, 15%, or 20% instead of gains from short-term investing which are taxed at ordinary tax rates and can be as high as 37% depending on what tax bracket you are in. This can have a significant impact on your returns over your investment timeline.
Long-Term Mindset
When investing having a long-term mindset is important. Most mutual funds underperform index funds because mutual funds come with heavy investment fees, short term tax rates, and trying to time the market. Short term speculators (most mutual funds) will try and time the market based on technical analysis which relies on a chart rather than a company’s fundamentals. Using the example from above, short term speculators will try and chase the market and it could reverse instantly without knowing the reason why. Now the speculators are at a loss and will sell to try and reallocate their position elsewhere, chasing the market. If you make an investment commitment to invest and hold for 10 years and the sector you invest in is in decline if you cost average bought that sector throughout the next year, your cost will be smoothed out and you will be less likely to lose money.
Steering clear of the noise in the short term can have a significant impact on your investments and can help avoid market volatility. Knowing that you have cost average bought, diversified, and have a long term mindset can help you feel secure during the down times and the up times, knowing you are in it for the long haul. Cost average buying decreases your risks of losses upfront which can give you a solid base to hold those investments and it also reduces your risk of market volatility in the short term. Having your money in different buckets reduces volatility in your portfolio and can balance out one asset class declining while another is searching for new highs. And the long-term investor will slowly build wealth over time knowing there money is being compounded over time and in it for the long haul.
If you have any questions about the principles talked about in the article, please reach out to talk to one of our experts.