How to React to a Volatile Market

February 16, 2016

Often referred to as “The Father of Value Investing,” Benjamin Graham says in his book The Intelligent Investor, “The investor’s chief problem – and even his worst enemy – is likely to be himself.”

Graham’s quote is in reference to the impact that investor emotions play on investment returns.  History has shown that investors are poor predictors of market returns. In the 20 years ranging from 1995-2014, a portfolio consisting of 60 percent stocks (S&P 500 Index) and 40 percent bonds (Barclays U.S. Aggregate Index) provided average annualized returns of 8.7 percent.  Over that same time period, the average investor’s portfolio return only 2.5 percent per year.  This disparity is largely attributable to investors making emotional decisions in attempts to predict market returns rather than staying invested during times of market volatility.  Accordingly, our first recommendation for dealing with market volatility is: Resist the urge to time the market—stay the course.

Another great quote of Graham’s is, “Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.” The take away from this quote is: Don’t worry—rebalance. When stock prices rise sharply relative to other investments, stocks become a larger percentage of the investor’s portfolio. Conversely, if stock prices fall in value, they become a smaller percentage of the total portfolio. Rebalancing causes the investor to sell the investments that have risen in value and buy investments that have fallen, forcing the desired behavior: Buy low and sell high.

Our final recommendation is: Continue investing—dollar-cost average. A Fidelity survey reviewing 401(k) investment performance during the bear market of 2008-2009 and the ensuing recovery, found that 401(k) participants that continued making regular contributions during the downturn experienced average account increases of 64 percent (though June 30, 2011) versus only 26 percent for investors who stopped contributing completely. Investors that make regular investments (whether through their retirement account or other brokerage account) take advantage of the investment principal of dollar-cost averaging. By making the same regular purchases of investments, investors buy a greater number of shares when prices are low and a lower number of shares when prices are high, thus decreasing the risk of buying a given investment at an unfavorable time.

In summary, while market volatility can be tough to stomach, it presents a time to affirm your long-term approach to investing rather change your strategy. Volatility is frequently healthy for the markets, presenting buying opportunities when investments are at lower values.