When the stock market gets volatile, retirement investors are naturally inclined to want to do something about it.
We certainly are at such a point now. The S&P 500 has plunged 21.1% so far this year, as of Wednesday’s close. Last week, it lost 5.8%, its biggest weekly percentage drop since the selloff inspired by COVID-19 in March 2020.
But doing “something” while the market is troubled just might be your worst move. The time to act is before the market gets rough, said Mitch Tuchman, managing director and chief investment officer at Rebalance, an investment management firm focused on passive index strategies. “It’s very important to anticipate the earthquake, and be seismically reinforced well before it occurs,” he said.
Anticipating the quake means adhering to three core principles:
Diversification: invest in low-cost mutual funds that invest in thousands of companies – far more than you could ever select, track and manage on your own. That gives you a measure of safety, since your exposure to sharp movements in any one stock or market sector is greatly reduced.
Balance: Invest in more than one type of asset (typically equities, bonds, and cash securities). This spreading out of investments is helpful because in any given year, one of these asset classes might be up while another is down. Balance helps smooth out the ups and downs. This can be done within a specific fund, or by owning two or three different types of fund that give you a reasonable balance among different investment types.
Allocation: Make a thoughtful decision about your exposure to equities that reflects both your tolerance for risk and the goals you are trying to achieve. The challenge at times like this is sticking with that allocation mix as market shifts distort your percentages. This is achieved through periodic rebalancing of the portfolio – when stocks are riding high, you sell enough to bring your allocation back to the targeted level and reinvest the proceeds in an asset class that is down. Rebalancing is a sell-high, buy-low discipline that can boost your portfolio performance significantly over time.
You can either do this kind of rebalancing yourself if you own funds that invest only in one asset class or the other; or, the process can be automatic if you own a fund that includes exposure to multiple asset classes, in which case those funds will take care of rebalancing for you.
KNOWING WHEN YOU’RE NOT SMART ENOUGH
Rebalancing can be tough. “It’s one of the most difficult things for investors to do in this type of market, when stock prices are falling,” said Julie Virta, a senior financial adviser at Vanguard.
But this approach can help you avoid the instinct to “do something.” One of my favorite comments on this was made years ago by Jack Bogle, the late, legendary founder of Vanguard. Asked by a Morningstar interviewer how long-term investors should react to volatility, he reiterated the value of broad diversification – owning a slice of the entire corporate economy – and letting those investments do their job over time.
“Then you’ve got to say, ‘I know I’m not smart enough to get out at the high. I know I’m not smart enough to get back into the low, so I’m just going to stay the course.’”
The stock market is adjusting to the new realities of interest rates returning to something akin to pre-COVID norms, and the economic headwinds of high inflation and global instability. The odds of recession also appear to be rising. But keep in mind that the breathtaking drops of the past few weeks come on the heels of equally breathtaking growth in equity valuations of late. The S&P 500 rose more than 16% in 2020 after plunging at the start of the pandemic, and rose a stunning 26.89% in 2021.
You might think the way investors are looking at the current market varies by age, since people more than 10 years from retirement have more than enough time to wait out the volatility before they begin tapping their nest eggs. But that is not what Tuchman sees in his practice.
“I know investors in their eighties who are just accustomed to the volatility, and others who have had bad experience,” he said. “Some of them were do-it-yourself investors who loaded up on one sector or another that never recovered from a big drop. It’s like thinking that every time you fly and there’s some turbulence – the plane will crash.
“So we have to explain to these people that an index portfolio survives and prospers, and comes out of these things.”
For people within ten years of retirement or already retired, having an adequate reserve of cash to meet short-term living expenses goes a long way toward easing nerves, added Virta.
“We usually recommend having six to 12 months of cash on hand to cover your expenses – that allows the balance of your portfolio to stay invested and maintain that long-term discipline.”
The opinions expressed here are those of the author, a columnist for Reuters.