What Smart Investors Do in Volatile Markets

2020 has been one of the most volatile years that the stock market has ever experienced. Just to recap the past few months: we hit all-time highs in February before the Coronavirus outbreak in the US and Canada. Then when the Coronavirus hit us, the markets dropped over 34%.

Since the end of March to early June, the stock market has mounted an incredible rally and even recorded the best 50-day stretch ever before it began slumping once again these past few weeks. Like most of you, I have been watching the news and pandemic updates to see its effect on the stock market. All of this news and fear created a whiplash response in the markets that nobody could expect with rapid increases and decreases in entire sectors occurring moments after each other. As nobody knows what the future holds and what could happen next, the question everyone is asking is what can I do to reduce this volatility in my portfolio?

It has been said time and time again that the smartest investors are the ones who forget about their investing accounts and do not check the day to day changes in their holdings. These are the words I try to follow but it is easier said than done. This is because most experts believe that the best thing you can do is to tune out all the news and the negativity of the world – especially if you are younger and are not planning to retire any time soon as you have time to weather the ups and downs of the stock market so that you can come out on top. This is because the smart investor sticks with a buy-and-hold strategy. This means that they purchase a stock / ETF / Mutual Fund for a time horizon exceeding 5 years so that the holding has time to appreciate (stock price increases) and over time will be worth more than what you has originally paid. 

This is because not paying attention and keeping your holdings over the long-term is the best thing to do as you can alleviate your stress and anxiety of the short-term fluctuations of the market. As an example, let’s say you have 100 shares of $1 in Company A. Your total portfolio is worth $100 on January 1^st. However, what happens if on January 2^nd the company is unable to produce their goods as their employees have decided to go on strike due to being underpaid. This halt in production scares investors into selling their positions quickly so as not to lose too much money from their investments. The stock price drops from $1 to $0.40. On paper, you have just lost 60% of your portfolio – dropping from $100 to $40 – in a single day. For the investors who check their portfolio every day, chances are you would probably sell out of fear of it dropping even more and losing even more money. You would than take that 60% loss and move onto the next stock hoping to make your money back quickly or you might even decide to get out of the stock market completely as you simply do not have the risk tolerance for such a steep drop to potentially occur again. On the other hand, the smart investor, who does not pay attention daily, misses this negative occurrence and holds until December 31^st – approximately 1 year – which gives the company enough time to deal with the ongoing strikes, to make a mutually-beneficial agreement. This agreements leads to their employees being more motivated to work hard since they are being paid their worth that increases their productivity. So the stock goes from $0.40 to $1.40 due to this increase in productivity (minus the additional cost of salaries paid to the employees of course), and the smart investor ends the year with a total portfolio worth of $140 and an increase of 40% on his original investment of $100. Now this might seem like a basic example but if you imagine this type of situation over multiple publicly traded companies and over a time horizon of 5+ years, you can easily tell that some companies might have bad days or months and that you should not let the fear of bad news dictate how you decide to invest your hard earned money.

For those who are struggling with their investments, particularly during these times of high volatility, I would recommend that you calculate your Market Exposure. Market Exposure = (Total Exposure to Equities * 50%) + Total Exposure to Bonds. This number, converted into dollars, would let you know how much of your investment portfolio were to be reduced if you lost 50% of your value. Please note that this is specific to equities rather than bonds as bonds do not decrease as drastically as equities – stocks, ETFs and Mutual Funds over a short period of time.

As an example, if you currently have an 80/20 percent split of equities and bonds in your investment portfolio worth $100,000, this would mean that you have $80,000 in equities and $20,000 in bonds. So your number would be ($80,000 * 0.5) + $20,000 = $60,000. So if the stock market crashes and you lose 50% of all of your equities, you would be left with approximately $60,000 in your portfolio instead of your original $100,000. Although this is a rough estimate, just knowing what that number is in your head can be very beneficial, as you know what the worst-case scenario could potentially be for your portfolio. This helps you rest easy and not worry if the market drops a bit every now and then and this also helps you to shake off any mild market drops and helps reassure you. Determining your number can also help gauge your risk tolerance and help you determine what portfolio allocation works for you. Usually, when you are young, you tend to push for a 90/10 split with a concentration of equities. If you are close to retirement, you might switch that to a 50/50 split with equal parts in equities and bonds so that you have less to worry about in your retirement years if the market remains rocky and volatile.

At the end of the day, your worst enemy is yourself. As long as you remember that drops are part of the stock market cycle and you do not begin selling at a loss, you will definitely retire having made more money in the stock market than you would have if you had kept that money hidden underneath your mattress.

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