Wealth Trends - How to deal with market VolatilityFeb 01, 2008 09:06PM ● By Don Kindred
by Michael Vandenburg, CFP®
You can’t really escape the financial news lately. Every day it seems we are either hitting new highs or new lows…and sometimes on the same day. When the market turns up the volatility like it has lately, it is enough to make even seasoned investors get a little nervous. I have had a lot of people ask me about what to do during times like these so I thought I would share a few insights into how to turn the market volatility to your advantage.
The first thing you need to do is to keep things in perspective. I’m not a short-term trader and would expect that most of you are not either. Investors should have at least a three-year time horizon on funds they have invested in stocks. Keeping that in mind, short-term volatility is just that: short-term. It can be painful at times, but it is still short-term. Looking at the market from a long-term perspective and sticking to your investment plan will help guide you through a volatile market.
Another thing to do is check the fundamentals. Technically, a correction is defined as a market decline of 10% from its peak… which is about where we stand as of this writing. Although people may throw around the term “bear market” as if we are already there, it hasn’t really been a bear market until we hit a 20% decline from the peak. Generally, the price of stocks should be a reflection on earnings and growth. Being that we are in a period where growth is slowing, it is not surprising that prices have come down. But if you look at the big picture, the S&P 500 is trading at about 16 times earnings, which is a discount to historical standards.
For a little perspective, in 2000 during last market peak, the S&P 500 was trading at more than 30 times earnings, and many stocks were trading at 100 times earnings or more. If you look at this another way, the S&P 500 companies back in 2000 were collectively earning a little over 400 Billion dollars and trading at a high multiple. Today, those companies are earning over 800 Billion dollars but are trading at a discount. This doesn’t necessarily mean that the market is going back up to those multiples, but the risk vs. reward scenario is much better now and the potential for the multiples to get back to historical norms are likely over the next 3 to 5 years.
So, if you are indeed investing for long-term goals, and you can handle the current volatility, then what can you do? One way to add value and increase long-term performance is to buy when the market is down. Especially when everyone jumps on the bandwagon and starts to talk about how bad the economy is and we are all going downhill fast. These are the same people that told everyone to buy more technology and that we were in a new economy back in 2000…just before the bubble burst. If you are investing on a regular basis and you notice market is down sharply over a few days, then go ahead and put your money to work. You might not get in at the bottom, but trying to time the market is never a good idea. You can take comfort in the fact that you were able to buy at a discount when the market was down and it will increase your long-term performance.
One more thing I suggest people do during volatile markets is to dump your losers. If you have some stocks in your portfolio that you haven’t sold because you have held them forever and don’t want to pay the capital gains tax, you can use the losses to offset some of the gains and rebalance your portfolio without tax consequences. Just make sure you match the gains and losses for long or short term and you know what you want to do with the funds next. If you are out of the market for too long you may miss a big rally.
Short-term volatility is common during all market cycles, but what you do during those times is completely under your control. Stay focused on your long-term goals, stick to your financial plan, and make the volatility work for you. b