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How to Navigate Stock Market Volatility

Sep 17, 2020 | 6 minute read

How to Navigate Stock Market Volatility

It’s hard to predict what could, and when something might, happen to the stock market – it’s constantly changing. There’s importance in realizing the stock market will have its ups and downs. Let’s take COVID-19 (Coronavirus) for example, many investors are wondering how their investments may be impacted. Historical perspectives, how emotions affect decision-making ability, and strategies to help investors live with market volatility are all things to consider when checking your investments when the market may be experiencing volatility.

Current Shocks in a Historical Perspective

We are all familiar with the COVID-19 pandemic and there are many changes we are facing because of it; the stock market is no different. In the diagram below, you can see the many fluctuations the stock market has experienced during this pandemic time period.*

Chart: S&P 500 Index Cumulative Return

While most investors know the market goes through cycles, it’s times like these when emotions run high. The past is not predictive of the future, but it offers valuable insight and perspective in understanding market volatility that has been seen before.

If we look at past epidemics, we can gain some insight into the potential impact COVID-19. While markets reacted to each new event in the short term, they have tended to reward patient investors over long periods of time. That said, we haven't experienced anything like the COVID-19 pandemic; it’s different in that it has caused a global economic disruption, triggering responses by world governments and has severely restricted economic activity and travel. Meaning, it’s difficult to predict how everything will pan out.

Chart: Cumulative growth of the S&P 500 Index

What’s Going on Inside Our Heads?

Image 3Emotions can impact how we respond to volatility and it's common to be uneasy when changes strike. Our frontal cortex processes information to help us make logical and informed decisions. However, the amygdala, or the reflexive brain, connects stimuli in the world around you to experiences, causing our reflexive brain to act on emotions.

Anchoring Bias

Another reason we get caught up in the volatility of the stock market is blamed on a concept called Anchoring Bias. Meaning, we often focus too heavily on one piece of information when making decisions. This has a powerful hand in our decision-making and can give investors a sense of false reality. Investors often abandon realistic earnings and expect strong returns.

For example, imagine investing $10,000 in 1989 and setting a goal to earn an 8% average annual return on your investment portfolio. With your goal set, you earn a consistent return over the entire period and the growth of your account would look like the blue line. Reality is the market doesn’t always react this smoothly and if the market drops, you may feel like you’ve lost, losing sight of the fact that you are actually still on track to reaching your long-term goal. It’s always important to keep focused on your long-term strategy and not let your anchoring biases steer you astray.

Chart: Growth of $10,000 investment

Loss Aversion

The pain we associate with a loss is much more intense than the reward felt from a gain. It is another fear-induced behavior many investors experience. Many investors are considered emotional investors, meaning decisions tend to be made to avoid the pain of loss. To avoid more losses in today’s markets, investors may be tempted to move their investments to a place they perceive as a safe haven now. However, investors may not realize that security comes at a cost.

Living with Market Volatility

So, what can we do today? There are three strategies that can help investors live with market volatility.

First, and arguably the most important concept of investing, is to stay calm and keep a long-term perspective. Remember, you are investing and working toward an end goal. You may experience ups and downs in the market, but if you can tune out the noise, it may help you stay calm and avoid acting on your emotions. Don’t over review your portfolio.

Second, diversification matters. Diversification is a staple of investing. It may reduce a portfolio’s overall volatility and provide a smoother ride through bumpy markets. The need for diversification can be depicted below as you can see how various asset classes performed on a year-by-year basis over the last 15 years. The best-performing asset class for each calendar year is at the top of each column. No asset class has consistently offered the best return year in and year out.

Chart: Annual Return of Key Asset Classes

To help reduce overall volatility and improve chances to earn more consistent returns over time, keeping assets across several asset classes helps avoid the temptation to try and time the market. In addition, as markets change, your portfolio may need to evolve. Times of volatility offer a great opportunity to reevaluate and possibly rebalance your asset mix.

Lastly, remember your strategy. While it may be tempting to pull out of the stock market during times of volatility, it is important to stick with your investment strategy. When emotions are running high, review your plans to keep yourself focused. A couple things to remember to keep your strategy in focus include:

  • Stay invested, short-term losses can trigger anxiety, but letting emotions drive your investment decision may prove costly. Focus on long-term results rather than the daily bumps along the way.
  • Dollar cost averaging may make it easier for investors to cope with volatility. Simply put, dollar cost averaging is committing a fixed amount of money at regular intervals to an investment.
  • Don’t time the market. Remember jumping in and out of the market can be costly. When markets become volatile, many people try to guess when stocks will bottom out. In the meantime, they often park their investments in cash. But many fail to see an upward trend in the market until after they have missed opportunities for gains. Missing these opportunities can take a big bite out of a return.

In short, history has shown us that while markets react to shocks in the short term, they have tended to reward patient investors over long periods of time. Our emotions can affect our decision-making ability in these times of market volatility, but as we now know, there are strategies we can keep in mind to persevere and help keep our goals in sight. For a further in-depth analysis on market volatility lead by Franklin Templeton's Vice President and Senior Advisor Consultant, Jennifer McFarland, please visit our CU Events page to view our on-demand webinar, Unchartered Waters: Navigating Market Volatility.

Have additional questions? Contact Investment Services, provided by CUSO Financial Services, L.P. (CFS),** today at: 513.243.6510 or email Erik Waldron at: erik.waldron@cusonet.com to talk about how you can navigate stock market volatility and how current events may impact your portfolio. 

 

View the Recording

 

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*This chart is for illustrative purposes only and does not reflect the performance of any Franklin Templeton fund. Past performance does not guarantee future results. Source: © Morningstar 2020. Larger growth stocks are represented by the S&P Growth Index; Large value stocks are represented by the S&P 500 Value Index; Small growth stocks are represented by the Russell 2000 Growth Index; Small Value stocks are represented by the Russell 2000 Value Index; Foreign stocks are represented by the MSCI EAFE Index; Bonds are represented by the Bloom berg Barclays U.S. Aggregate Index; High yield bonds are represented by the Credit Suisse High Yield Index; Emerging market stocks are represented by the MSCI Emerging Markets Index; Global bonds are represented by the FTSE World Government Bond Indexes; Hedge Strategies are represented by the HFRI Fund Weighted Composite Index. Indexes are unmanaged and one cannot invest directly in an index. Index returns do not reflect any fees, expenses or sales charges. Diversification does not guarantee a profit or a protect against loss.  

**Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a Registered Broker-dealer (Member FINRA/SIPC) and SEC-registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. General Electric Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.

Franklin Templeton, “Uncharted Waters: Navigating Stock Market Volatility in a Coronavirus World.” 2020.