Warren Buffett, arguably the world’s greatest investor, wrote in his 1993 annual letter to Berkshire Hathaway shareholders, “In the short-term, the stock market is a voting machine, reflecting a voter registration test that requires only money, not intelligence or emotional stability, but in the long run, it is a weighing machine.” It is hard to overstate the importance of this quote. In the short-run, the market moves on emotion, based on the current events of the day: COVID-19, the Russia-Ukraine war, or the most recent economic statistic. In the long run, however, stocks tend to rise based on earnings growth, return on invested capital, and dividends paid. And for well over 100 years, earnings and dividends have moved higher as innovation, hard work, and the human spirit have improved living standards around the globe.
The stock market has been especially volatile this year, with moves of plus or minus one percent seeming to be the norm. While the short-term moves can be scary, investors can draw some comfort if they have a long-term investment plan.
Here are five things to do during market volatility.
- Stay Invested
The adage “buy low, sell high” is easier said than done. To make money when market timing, you must be right twice. You need to “sell high” at the right time, but you also must “buy low” at the right time. Academic studies indicate that investors fail miserably at market timing. If you stay invested during a market downturn your account, for a period of time, may be lower than before. But if you don’t sell you haven’t “locked-in” a loss. The market has always recovered with time and account balances have moved higher.
- Keep investing
If you have the means, you should continue to invest during a market downturn, especially if your time horizon is more than five years. Over the last 50 years, rolling five year returns for the S&P 500 have been positive 92.28% of the time. Investing on a consistent basis helps smooth out the ups and downs of your average purchase price, often lowering it over the longer term. This is known as dollar-cost averaging. By investing at regular intervals, you reduce your risk since you won’t be investing all your money when the market is at a certain price point.
- Rebalance your portfolio
Most investors have a “target asset mix” of stocks and bonds based on their age, risk tolerance, and other factors. Often, when one class of assets is declining (stocks), another asset class is rising (bonds). If you rebalance your portfolio regularly, you will be buying “discounted” assets to bring your portfolio back in-line with its target asset mix.
- Take some tax losses
It’s best to speak with a tax professional before you engage in this strategy but taking losses in your taxable portfolio can help lower your tax bill. The strategy, known as tax-loss harvesting, is the practice of selling an investment for a loss. By realizing, or harvesting, a loss, investors can offset taxes on gains and income. During major market downturns, this technique can help ease the pain of market losses—but it’s important to reinvest the money you raise when you sell, or you may miss any market rebound.
- Be a bit more cautious if you plan to retire soon
One group that could be the most affected by a stock market decline are those facing impending retirement. As noted earlier, over rolling five-year periods, the stock market bounces back over 92% of the time; but what strategy can help you get through the lean years waiting for the market to rebound if you are entering retirement? One strategy is to keep a few years of living expenses in cash and short-term securities like US Treasuries. While these investments may not make much money over time, they will protect the principal you need to withdraw for living expenses.
As others are panicking, investors with a long-term plan can use a market downturn to their advantage. Stick to the plan, invest/rebalance into cheaper assets, and lower your tax bill while patiently waiting for markets to recover.
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