Volatile markets can be stressful. Strategic planning can ease the impact.
The market is up one day, you feel good. The market is down the next, you feel stressed. The emotions of greed and fear, the driving forces behind investing, can create havoc without a good understanding that volatility creates opportunity. ”Be fearful when others are greedy and greedy when others are fearful.” Warren Buffet’s philosophy takes discipline and I assure you that a good understanding aids in that discipline.
Last year the longest running bull market came to an unexpected end right in the middle of an economic boom. In February we began experiencing extreme volatility as unknown factors entered the market. As we waited to see how supply chain disruption would impact the world economy, we began to experience disruptions to commerce in our own economy.
COVID-19 exemplified why we should always prepare for the unexpected.
Stock market values did return within a few months. Of course, that is not an indicator that they will in the future when a market disruption happens. After the recovery our nation began to experience extreme political division starting with urban riots across, morphing into highly contested election returns that still continue in some states now and a political change in the White House.
Regardless of what happens with these issues or future matters the following will help.
Investors should establish an emergency fund early in their financial plan implementation. The account should be about six months of your minimum expenses with an extra cushion for good measure. The last thing that you want to happen is to be forced to sell securities when the market is down to cover bills should your income be disrupted.
The money should be held in a cash position like a money market fund or savings account. I recommend that it be in a separate account earmarked for its special purpose as opposed to holding it in a checking or investment account with other money. The absence of volatility is the goal.
I discussed this topic in a previous post. Asset allocation is the process of diversifying your portfolio in a way consistent with your goals and risk tolerance. Historically, when stocks decline bonds go up giving the investor balance.
If your portfolio was properly allocated when the coronavirus market impact first hit chances are you’ve not had to make many changes. If not, now is a good time. Equity markets have bounced back with NASDAQ setting a new record.
Dollar Cost Averaging
Volatility is a friend to dollar cost averaging for investors who are investing money monthly. The key is to purchase an equal dollar amount of a security at regular intervals regardless of price. Let’s say you’re
investing $1000 per month into an exchange traded fund, for example. If the price per share is $50 when you start, you’ll buy 20 shares. If volatility to the downside overtakes the market and the share price falls to $40, you’ll buy 25 shares that month. No luck is needed to try to hit the perfect time to buy.
Opportunity to Double Down
Just imagine that you purchased shares of a security and it started going down as soon as you did. Now you have to wait until it returns to your original purchase price just to break even. But, when prices go down it’s really an opportunity, especially if you already believe in the security enough to have bought it the first time.
We all know that we should buy investments that we believe in long-term. So, if you believed in a security at $50, you should love it at $40. Not only is there an opportunity to buy something at a lower price, there is the bonus that when you double down you get back to the break-even point faster. When you buy the same number of shares at $40 as you did at $50 then the security only needs to make it back to $45 for you to hit break-even.
Tax Loss Harvesting
I wrote recently on taxes related to investing. I recommend you read it for information on tax management. Here, I’ll revisit tax loss harvesting as it relates to market volatility. Current tax laws allow us to reduce capital gains by our capital losses. The wash-sale rule prohibits investors from trading in the same or “substantially identical” security 30 days before or after the sale of a security at a capital loss. Otherwise, the IRS may disallow your tax write-off.
Selling securities at a loss and reinvesting into something that is not substantially identical is a strategy to take advantage of market volatility.
If you are using an asset allocation model program chances are that you are on a regular rebalancing strategy. Since asset classes don’t all move in the same direction at the same pace a portfolio can become out of balance from its original strategy. When the asset class percentages are brought back in line the classes that have gained the most are sold and the proceeds purchase the asset class that has gained the least or even lost value. It’s a planned “buy low, sell high” event. In times of excess volatility the percent of asset class representation can become exaggerated. It may do you good to do an unscheduled reallocation to hit a bonus buy low, sell high event.
Historically, when the stock market goes down people turn to dividend stocks to earn something while waiting for growth to return. Obviously, more buyers would slow the decline of those stocks during a volatile sell-off. An added bonus happens when you are reinvesting your dividends. It’s like dollar cost averaging with your dividend payments purchasing shares at regular intervals. You’ll get paid to wait for the recovery and have more shares with which to recover.
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