Ryan Derousseau, Senior Contributor
Jan. 31, 2022
Here we go again.
The stock market at times can do some very scary things. It’s possible that the market has entered a cycle where those scary things may happen more often than normal.
In January alone, there’s been three days where the potential for a correction – or a 10% fall from the market peak – could have occurred, before a bounce-back denied the arbitrary checkpoint to trigger. This has left investors skittish, worried that a correction could lead to further declines.
But for those investors in the market saving for retirement and long-term goals, it’s also a scheduled reminder that you should probably do very little in response to the volatility that the market seems to be displaying.
What’s driving this volatility is any number of factors. Inflation’s role certainly has an impact, as it has forced the Federal Reserve to consider increasing interest rates and cut money from its balance sheet (a tactic used to de-fuel an economy). COVID-19 also remains a factor, particularly with infection rates still high due to the Omicron variant. And the tug of war in Ukraine also plays a part.
But none of these shifts require long-term investors to make significant changes to – if they have a diversified portfolio that matches their risk tolerance, time until retirement and goals.
It Doesn’t Portend a Bear Market
First, to address the fear of a market downturn. It’s important to remember that even though a correction could occur soon, it doesn’t portend that a market downturn will then follow. Since 2000, according to Yardeni Research, the market has seen 11 corrections. Only three times out of those 11 did the market then fall 20% or more, which is the measure of a bear market. The most recent one occurred in 2020, due to the onset of COVID, when the market fell 34%.
More importantly, if a correction occurs and it leads to a downturn and corresponds with a recession, even then it won’t likely last very long. Market downturns, on average, end within 14 months.
Trust Dollar-Cost Averaging
While the market struggles, it’s an opportunity for long-term investors to buy stocks at a discount. This is the value of dollar-cost averaging, or buying stocks and bonds at a regular interval (like once a month) using a similar sum of money each time, whether the price of the market increases or decreases. This strategy allows you to purchase less shares when the price of the stocks or fund is expensive and more shares when the market drops.
If the market drops, then you’d buy more shares by simply doing what you always do, since now the price per share has also fallen. When the market rebounds after the fall, then you have more shares to compound, increasing returns.
While you never want to see a market drop, if you have a long time horizon to accumulate wealth, then a market drop actually provides you with the ability to boost the portfolio (assuming a rebound occurs). The only way dollar-cost averaging doesn’t work: if the market moves forward forever, without dropping in price. It’s safe to assume that won’t happen anytime soon.
If you don’t already use this method, then it’s a good time to start. If you contribute to an employer-sponsored retirement plan, then you probably already do.
Shift Your Portfolio
If the current news cycle, whether it’s inflation, the Fed or COVID, has kept you up at night for fear you won’t be able to manage the loss, then it’s time to look at your asset allocation. Instead of selling, this involves rearranging your portfolio to better match your risk tolerance, or comfort-level with volatility in the market. You don’t want to sell every time the market falls and having the proper asset allocation allows you to align your portfolio to your emotions.
It’s common for younger investors who have a long time before retirement and need for the money to have asset allocations that range from 70% to 90% stocks and the rest in bonds. For those near retirement, it might shift to 50% stocks and 50% bonds. But no matter your age, you also need to account for your willingness to stick out market declines.
The worst thing you can do is sell in the middle of a correction or downturn because you’re selling at a discount. Then, when you go to repurchase the assets you sold, you’re buying back in at a higher price. Rarely, if ever, will you time the market bottom perfectly.
Instead of selling, look to this asset allocation.
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