Despite your best efforts, you won't always be able to determine why an unstable market happens when it does. Put simply, the market is driven by people. And people sometimes act irrationally.
Take the recent fall in the Chinese stock market, for example. The market was up more than 100 percent from the previous year, throwing seasoned investors into a frenzied speculation as to when it would fall. The reality? The Chinese market fall had absolutely no logical reason to affect the best stocks of the Dow and S&P 500. But it did— many economists agree the U.S. market fell due to panic and overestimating its impact on the U.S. economy.
This is "the game" of the stock market. As well as why it is so important to strategize a healthy portfolio which can weather potential storms. In this article, we'll discuss 7 tips for storm-proofing your investment portfolio.
1. Choose a Comfortable Level of Risk
We've all heard the saying "With great risk comes great reward." Unfortunately, whoever coined the catchphrase never turned over their silver dollar. The other side to the popular statement is that with great risk comes great loss. The stock market is dual in nature. Meaning, you cannot have one without the other. And, though it often frustrates the clients of advisors, the reality is they can't determine your ideal risk level. They can help you make an informed decision, but that decision is ultimately up to you. With proper analysis of time horizon, financial projections, and risk tolerance, an advisor can help you find the risk level that's right for you. A helpful rule of thumb? If you're not sleeping at night, your risk level is too high!
A potentially helpful measure for gauging risk tolerance is asking yourself: How did I handle it the last time the stock markets went bad? Did you leave your investments alone, sell them or buy more?
2. Be Well Diversified.
Diversification is like insurance, preventing widespread portfolio destruction in the face of unstable markets. According to academic research, 90 percent of portfolio performance comes from being properly allocated (stocks, bonds, and cash) and globally diversified. While a mere 10 percent comes from individual investment recommendations. Maintain investments in various asset classes, and you will reduce your overall risk. For example, say you hold equal investments in 20 different stocks and one tanks. At the end of the day, you would have a portfolio that is still worth 95 percent of your original amount.
3. Choose Quality Investments
What is a quality investment? It's one that's proven relatively stable, dependable, and long standing. It's also an investment which meets your needs in terms of time frame and overall goals. Though it may be tempting to buy up stock in fly-by-night companies, you are risking substantial loss should those assets lose value. A quality investment doesn't rely on "hope." And owning stock in a poor company never helped anyone! Instead, work with your advisor to select a healthy mixture of blue chip investments.
4. Maintain Long-Term Perspective
Though it may seem obvious, it bears mentioning: Trading from a place of greed or fear rarely yields positive outcomes. In fact, both can be disastrous to the portfolio you have worked so long to build! When in the midst of an unstable market, it is important to remember this is exactly what you planned for. Now is NOT the time to abandon ship. Instead, stay attuned to your long-term goals and focus on what you can control.
5. Tune Out The Talking Heads
In most cases, the financial news pilfered by the media is, at best, unhelpful (and at worst, harmful). By the time market information reaches a reporter's desk, things have moved behind the scenes to such a degree that the information contains little value. Also, consider the source. Do you think financial TV personalities prioritize delivering the best possible advice or high TV ratings? After all, drama makes great television! Instead, take your advice from someone whose interests line up with your own.
6. Know When to Sell (and When Not to Sell)
Despite the uncomfortable level of uncertainty they create, unstable markets often move in a way which creates opportunities for smart investors. If you and your advisor are confident in your fundamental plan don't sell. Conversely, if you find some undervalued investments of interest, now would be an opportune time to consider buying. Depending on your retirement time frame, and the amount of cash at your disposal, you may have the opportunity to secure standout stocks at value prices. Just remember to do your research and to only act within the level of risk that is appropriate for your goals.
7. Have a Plan Already In Place
Finally, the most important component to weathering market stability is having a solid investment plan in place. Being able to refer to a strategic plan in the midst of volatility is important. Though you may feel some anxiety watching markets fall, you're much more likely to "stick to your guns" with a research-based plan in place.
If you are receiving income off your portfolio, be sure to maintain 1-2 years of that income in cash. Should markets become unstable (specifically down), you won't feel forced to sell investments at a low price to create an income. With some cash set aside, you'll be able to delay selling until the market recovers.
As you can see, an unstable market doesn't have to be an overwhelming source of stress or contention. With proper portfolio planning, mental discipline, and an evidence-based approach, you can feel confident in the strength of your portfolio during periods of fluctuation.
