Market Volatility, Should I Get Out of the Stock Market?
By Pinyo • Jan 23rd, 2008 • Category: InvestingWith the recent stock market volatility, I am sure a lot of us are having second thought about the stock market. Some may even ask, “Should I get out of the stock market?” The answer is it depends. Personally, I am holding steady and continuing to invest for the long-term. I can do this because I have the right asset allocation and investment mix for my investment time horizon and risk tolerance.
4 Steps to Evaluate Your Investment Strategy
Risk Tolerance Level
Did you take one of those risk tolerance tests, such as this Basic Risk Tolerance & Asset Allocation Calculator way back when? Did you get a rating like “aggressive investor” or “very aggressive investor”? Now fast forward to 2008, is the current market volatility and stock sell-off making you nervous and you’re second guessing yourself? If the answer is yes, then this might be a good time to re-evaluate your risk tolerance level. Whether it was a long time ago, or you were overly optimistic, it’s normal for your risk tolerance profile to change with time.
Understanding your current risk tolerance level and where you stand is a good place to start.
Investment Time Horizon
Even if you are still optimistic and your risk tolerance level still says you are an “aggressive investor,” you should determine if your time investment horizon changed from the last time you considered it. This is not only about age. Your life situation and financial priorities could have changed — e.g., you’re getting married, saving money to buy a house, having a child, going back to school, etc.
As your life situation changes, you may have to adjust your investment strategy to fit the current needs.
Asset Allocation
Does your asset allocation align with your risk tolerance level and investment time horizon? If you have been religious about rebalancing of your portfolio, but haven’t considered risk tolerance level and investment time horizon for a while, this may be a good time to take a good look at it. These tools can give you some ideas about where to start:
Does your current investment mix in line with the ideal asset allocation?
Diversification
Does your investment consists mainly of individual stocks? If it does, I recommend that you read Wise Investing Made Simple: Larry Swedroe’s Tales to Enrich Your Future by Larry Swedroe. Larry believes that the best investment strategy is to be a disciplined, long-term, buy-and-hold investor that utilizes globally diversified portfolio of low-cost, no-load, and passively managed funds and ETFs. I also believe in this strategy.
Now let’s take it a step beyond the typical diversification when we think about investment — i.e., stock vs. bond, large-cap vs. small-cap, domestic vs. international, value vs. growth, etc. Do you have other types of investment that are generating alternative income, or appreciating in value? For example:
- Business investment
- Real estate investment
- Precious metal and gems
- Debt investment
Do you believe your investment portfolio is diversified?
Possible Investment Tactics You Can Use
You shouldn’t let emotion drive your actions. The worse thing you can do is check the stock market daily and react to every ups and downs. However, there are practical investment tactics that you could consider:
- Determine your ideal asset allocation and adjust your portfolio toward it. There are two ways to do this:
- You can slowly adjust by adding new money toward the under-represented investment classes, or
- You can rebalance existing investment to immediately achieve the ideal allocation.
- Sell losing stocks and mutual funds to capture losses for tax purpose.
- Switch from mutual funds to low-expense Exchange Traded Funds (ETFs). There are two reasons why you may want to do this:
- When money is exiting the fund, the fund manager is forced to sell the underlying stocks. When this happens, the fund could generate capital gains even while it is declining in value. With volatile stock market, I suspect that a lot of funds will lose value and generate large capital gains distribution, resulting in mutual fund double whammy losses.
- Saving even as little as 0.5% on average expenses ratio can have a huge impact on investment performance. For example: $10,000 gaining 30 years at 10% with 1% expense ratio will grow to $129,000, as opposed to $150,000 at 0.5% expense ratio!
I know watching your hard earned money going down the drain is hard. However, it’s better to act with reason, than to react with emotion.
More about volatility and stock market decline:
- World Markets Plunge: What should investors do (a multiple choice question)? @ The Dough Roller
- Market Falling, and now I’m in the market @ Mrs. Micah
- Reader Question: Bear Market Worries, What About My Roth IRA? @ My Money Blog
- Some Solid Advice From Larry Swedroe: Don’t Let Emotions Take Control @ All Financial Matters
This post was featured in:
- The 73rd Edition of the Festival of Stocks hosted by My Adventures into The Street. For more information please visit the Festival of Stocks.
All posts by Pinyo
Very good advice - I think the most important thing when making decisions about your portfolio is not to panic and have some good logic or reasons why you are making changes.
And of course, not making any changes is a good move too (usually).
Mike
In my opinion, there is absolutely no reason to sell.
If you’re investing in the market for the long term like you should be, this current market behavior will have no affect on your portfolio.
If you’re trying to day trade or hold things for a short term, you made a mistake before you even started and now you’re seeing exactly why what you did was a bad idea.
It’s that simple.
Nice post, well thought out. You addressed all the things that are important to look at, regardless of current market volatility. But this certainly is a good time to re-examine all of it.
One thing to add, having a financial plan in place helps investors to keep all of this market volatility in perspective. Knowing the answer to a question like: How does a 16% drop in my investable assets effect my projected retirement lifestyle is important.
Been trying to write a response to this post for almost an hour, but keep getting interrupted by client phone calls asking about what’s happening…
@FourPillars - Thank you. I wouldn’t call it advice. These are the things that I do myself, and not because of the market decline. I always go through the steps each time there is a major life event, and also in the December of each year.
“And of course, not making any changes is a good move too (usually).”
Definitely, if you started with a good plan in place.
@Kevin - “In my opinion, there is absolutely no reason to sell.”
I agree, selling is one of the worse reaction to down market. Unfortunately, that’s what a lot of people ended up doing.
@Ciaran - I look forward to your follow up post. Let me know when it’s done.
I am sure you’re getting a lot of phone calls today.
Solid advice. Hopefully people near retirement actually have enough diversified into cash, CDs, and bonds. And the rest of us have a while yet.
Thanks for mentioning my volatility primer, but mostly for pointing to the asset allocation tools. It’s about that time for my portfolio.
@Mrs Micah - Thank you.
“Hopefully people near retirement actually have enough diversified into cash, CDs, and bonds.” Agreed, but not too much still because most people still have another 15-25 years to go after retirement.
@Lily - You’re welcome.
Absolutely stay in the market if you’re under 50. The market always comes back. If it didn’t, I think we’d have bigger things to worry about.
ruff ride at the moment and for the next 12 months but something i’ll be riding out. I’m in for the long haul