Strategies for Dealing with Market Selloffs

***This is a repost from our blog back in December when we last saw market volatility. Today, concerns are centered around escalating trade tensions between the US and China. A trade war could be the catalyst for the next recession…or simply a negotiation tactic ahead of a trade deal. There is no way to know now but also nothing any of us can do about it. This post focuses on the things you have control over

Corrections happen.

Bear markets happen.

Of course, no one likes seeing their investments lose value but knowing and expecting these things will happen is a necessary prior to investing in stocks. We’ve written on the topic of market selloffs routinely because market selloffs happen routinely.

By now, you’ve probably seen us offer evidence that market timing doesn’t work. Everything from why the old adage “sell in May and go away” is a bad strategy to how buy and hold beats “playing it safe” to the simple fact that for market timing to work, you have to be right twice. We’ve shared how future return expectations are higher after large selloffs (1) (2) (3) and how being out of the market during one of the top-10 trading days is disastrous for portfolio returns.

We’ve shown there are always headwinds in the market and we’ve written about them through the years. Investors who sold on US valuation concerns in 2014 missed out on the 41% gains that occurred since. Are you still afraid of China devaluing the Yuan in 2015? Or of the Fed’s end of Quantitative Easing? How about 2015’s collapse in oil prices and earnings recession? The point is there is always something to worry about and there are always headlines to capitalize on that fear.

For investors with a long enough time horizon, stocks offer higher average returns with less volatility than asset classes considered safer in the short-term, like bonds. The challenge is getting to that long enough time horizon. The Behavior Gap is real because long-term investing is hard. Study after study (Dalbar, Morningstar, Vanguard) shows that making changes to a long-term investment plan is detrimental to returns. Yet, investors continue to make these harmful long-term decisions to (hopefully) avoid short-term pain.

We’ve presented evidence on why keeping the faith is essential to successful investing and advised that the only way to achieve the returns promised by stocks is to expose yourself to every market panic. But we haven’t offered strategies on how to stay invested when times get tough.

Here are a few strategies that can help:

1. Expect Volatility: Recency bias tells us that we remember events that happened most recently better than events further back. This bull market has been marked by long periods of tranquility making it easy to forget selloffs are common occurrences. Bearing short-term risk is the price to pay for higher long-term returns.
2. Avoid Frequently Checking on Your Investments: This may sound like almost irresponsible advice but investors tend to check on their portfolios more during periods of market distress. This action can make it seem like your investments are performing worse than they actually are, especially when you consider humans feel the pain from losses more than the joy from gains. If you log into your account more than once a quarter, you are probably logging in too much.
3. If the Market Proves Too Stressful, Consider Tweaking Your Risk Allocation Rather than Making Wholesale Changes: We are all unique and have our own risk tolerance levels. Sometimes we don’t know that an asset allocation is too risky for us until we are in the middle of a correction. It is, however, the wrong time to make big changes when stocks are selling off and emotions are high. Consider turning down the risk dial rather than switching it off and hold out until conditions stabilize before reevaluating your overall asset allocation. This is not as good a solution as staying invested but is a lot better than whipsawing from 100% invested to 100% cash.
4. Get a Second Opinion: Call us and talk to your advisor. Advisors earn their value during market selloffs by providing calm, reasoned advice. Before making any decisions, let’s have a conversation – we are here to listen to your concerns and to help guide you through both up and down markets.

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