Keys to Surviving Market Turbulence
Investors were in sell mode ahead of the weekend, and again on Monday, as the major US stock markets sold off substantial amounts and officially entered the technical definition of a market correction (which means dropping 10% from the stock market’s previous high water mark). This was the first stock market correction in just over 1,450 trading days, and most of the investment community felt it was long overdue.
What caused the recent sell off? Mostly, the reason has been continued poor domestic economic data around lower oil and other commodity prices, and the news that China’s economy is most likely slowing faster than the Chinese government would like the rest of the world to know. The headlines of the past few weeks have had their negative impact on the market, and may continue to affect share prices for a while longer.
Dealing with troubling worldwide news and the accompanying falling stock prices is not easy. All too often, investors react to a sharp drop in prices by panic selling. They see the financial media flashing headlines such as “Investors Flee the Market”, or hear statements such as “today was a blood bath for the stock market” and get the impression that no one is buying. But, the fact is that every transaction includes a sell and a buy. So, for every seller who fled the market in panic, there was obviously a buyer waiting to take advantage. For a change, it would be nice to see a headline that says, “As some react negatively to news from China, greedy investors scoop up shares of stocks on sale!”
Any time you are feeling nervous about any adverse market event – whether it is a one day blip, a more lengthy market correction (a decline of between 10% to 20%), or 
a prolonged bear market (a decline of more than 20%) – Please take time to call your Vermillion Financial Advisor for a portfolio review, or just to discuss how you are feeling. It will help you deal with the concerns that market volatility can bring.
Here are five suggestions from our advisory team to help you and your portfolio survive market turbulence.
- Don’t Panic and Sell Everything… The reason most investors invest in stocks over bank CDs and corporate bonds is because of the higher long-term returns. However there is no free lunch when it comes to owning stocks; with greater return comes greater volatility.
Ask yourself, “How did I make it through the last major stock market decline?” For most of us, that means reflecting back seven years to 2008 when the stock market posted a negative return of -37%! Did you do anything different in 2008 than you did during any of the other previous bear markets of the past 50 years (2001, 1998, 1990, 1987, 1980, or 1973)? Did you realize that it took 47 months for the market low of March 9, 2009 to return to the market’s previous high?
It’s even easy to forget the more recent past. Do you recall back in 2011 when the Dow fell 635 points on August 8th, only to rebound 430 points on August 9th? Do you recall that this was followed by another 520 point dive on August 10th, and then immediately followed by another increase of 423 points on August 11th? Most likely you do not recall that week. Why? Mainly because it was short lived. The market calmed down quickly that year and returned to moving toward new higher levels. Of course, past performance is no guarantee of future results. However, historical performance does illustrate that we’ve experienced similar volatility before, and eventually recovered very well.
Rarely does anyone (including financial advisors) have the ability to pick stock market peaks or valleys. If you were one of the few that did sell out last time your portfolio experienced abnormal volatility, ask yourself, “How did selling out my investments work for me last time?” Were you able to successfully sell out at the top of the market, and then successfully buy back in at the bottom? Were you invested when the market bounced back? Most likely the answer is, “Of course not”. Most investors who sold out fared much worse than those who maintained their holdings.
All experienced VFA advisors know that when an investor has reached a level of financial distress whereby they demand the liquidation of all their investment holdings, it will take two necessary factors to change their mindsets and allow them to re-enter the stock market in the future: Time and Confidence.
Time helps to resolve the emotional stress that comes from experiencing volatility and loss, but confidence only returns through the experience of positive stock market movement. This means that the average investor will only be comfortable reentering the stock market after it has reestablished a new track record of positive returns, and when volatility has returned to perceived normal levels.
- Please don’t be impatient… The common recommendation advisors give to investors is to “sit tight and stay the course”. This is always much easier said than done, especially as you look at your negative return account statements. “Investor portfolios will eventually recover” is a phrase of little comfort in the midst of a bear market (even though this has always been the case since the start of the modern US stock market).
You will not be able to tell by your lower account balances, but most bear markets or market corrections do not last as long as you may think, and you may not have to wait too long for your portfolio to bounce back.
Did you know? Since 1926, it has taken an average of 39 months for stocks to surpass their previous high points, meaning that the financial markets tend to reward investors who demonstrate discipline. For example, in spite of events including the oil embargo and S&P 500 drop of 45% in the 1970s, the 2001 dot-com bubble, the 2008 subprime mortgage crisis when the S&P 500 tumbled 46%, and the 2011 government’s fiscal cliff crisis, one dollar invested in the MSCI World Index (net dividends) from 1970 until 2014 is worth $45 today. That is an annual average rate of return over this 45 year period of just under 9%, which is pretty good by most investors’ standards.
- Talk to your Advisor… Your Vermillion Advisor is always available to help you separate emotionally driven decisions from those based on your goals, time horizon, and risk tolerance. Researchers in the field of behavioral finance have found that emotions often lead investors to read too much into recent events, even when those events do not reflect long-term realities. With the aid of your VFA Advisor, you can sort through these distinctions, and you’ll likely find that if your investment strategy made sense before the current market correction, it will still make sense afterward.
- Keep a long-term perspective… A buy-and-hold strategy can help. That means making an investment, and then holding on to it despite short-term market moves. Maintain focus on your long-term investment goals and the investment plans that you have set up with your VFA Advisor.
The only certainty about the stock market is that it will always experience ups and downs. Corrections are normal by historical standards and the recent volatility is well 
within the norms. Generally, stock markets post a negative annual return for 25-30% of the time. That’s why it’s important to keep emotions in check and stay focused on your financial goals.
Try not to be distracted by the 24-hour financial news cycle that’s fixating on headlines, and where every available expert is there to fill space and boost ratings by explaining the cause and effects of short-term market volatility. It’s just media spin.
The opposite of buy-and-hold investing is market timing, which is buying and selling investments based on what you think the market will do next. Market timing, is risky and never recommended by VFA Advisors. There are only three possibilities following a market correction: the market could drop some more, it could stay flat, or it could reverse course and start heading back up. No one ever knows what will happen next.
Studies show that with market timing, your portfolio decision making and the timing of your financial buy and sell moves need to be correct 80% of the time in order to outperform a buy and hold strategy. So why even try to beat those odds? If your predictions are wrong, you could be investing when the market is on its way down or selling when it’s on its way up. In other words, with market timing you risk buying high, selling low, locking in a loss, owing taxes on formerly deferred profits, and/or having your portfolio sit in cash while you miss the best performing days of the market as it recovers.
- Review your Capital Preservation Policy… While it’s important to remember that periods of falling prices are a natural part of investing in the stock market, Vermillion clients who have a recently documented Investment Policy Statement (IPS) also have a written Capital Preservation Policy (CPP). A CPP includes pre-planned action steps to be taken when volatility rises above normal levels.
Your advisor has a variety of tools to use to address volatility in your portfolio, including automatic stop losses (a predetermined move-to-cash plan coupled with a market re-entry plan), opportunistic portfolio rebalancing, and options written against individual stock and stock indexes to hedge your portfolio against a sudden drop in the market.
Therefore, as the current news continues to grab our attention, it’s possible to calm your corresponding market and investment concerns. Just think of your Capital Preservation Policy as your portfolio’s “guardrails”, wisely put in place by you and your Advisor.
As Peter Lynch, the legendary and successful 1990s manager of the Fidelity Magellan Fund reminded us back in 2014, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
In the end, these are the best moves you can make right now:
- • Harvest any capital losses currently available in your portfolio, and bank these losses so that you can offset future capital gains from taxes
- • Update your risk assessment and re-evaluate your risk profile as this limits the overall risk of your entire portfolio
- • Redirect your focus on the fact that you are a long-term investor
- • Have a discussion of any issues and concerns you may have with your VFA Financial Advisor
- • Remember that all market corrections are just temporary.
You must understand that market corrections (even large ones) are normal, and they occur regularly.
This understanding allows you to make non-emotional and logical decisions about your portfolio, and that is how you survive a market correction.
Note: The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendation for any individual. Please remember that past performance of investments may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this post serves as the receipt of, or as a substitute for, personalized investment advice from Vermillion Financial Advisors, Inc. To the extent that a reader has any questions regarding the applicability of any specific issue discussed within this newsletter to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. A copy of our current written disclosure statement discussing our advisory services and fees is available for review upon request.
[sgmb id=1]
Continue reading and jump to the next post,
Leaving a different kind of legacy
Charles Schwab