In Volatile Markets, Focus on What You Can Control
The first quarter of 2018 was a good reminder that stock markets can be volatile at times. The 15-month market rally following Donald Trump’s election in November 2016 was an unusually smooth ascent that involved very little turbulence or significant market drawdowns. If nothing else, the past few months are a return to normalcy, where markets don’t just go up. While periods of sustained equity growth are emotionally – and financially – satisfying, they also create a false sense of security for investors who might forget that investing money involves various degrees of risk.
The S&P 500 has corrected roughly 10 percent from its January high and currently sits in negative territory (-1.28%) year-to-date. This is a good time to remind people that most years involve a double-digit percentage drawdown at some point – even in strong market years! The chart below is from J.P. Morgan and is a nice illustration of the consistent intra-year market volatility over the past 40 years.
Since March 1st, we’ve seen 14 trading days where the market has moved more than one percent (7 days positive, 7 days negative). This type of volatility can be unsettling for investors. It makes them question their approach to investing and wonder if they should be trying something different with their portfolio decisions. Since successful investing is more the result of investor behavior than brilliant investment acumen, these are good times to focus attention and effort on the things that you can control – as opposed to the thousands of daily factors that are beyond your reach.
Here are some things that individual investors cannot control:
The performance or business operations of the companies you’re investing in
The collective decision-making of the millions of other people who are moving the markets each day
Taxes and regulation that affect domestic and international economies
Random current events (terrorism, extreme weather, etc.) that occasionally shock the markets
Donald Trump’s Twitter handle
But there are a lot of important factors that are completely in your control, and ultimately much more determinative of your investment performance over the long-term. These include:
Your Savings Rate:
The best way to grow your portfolio is to simply save more money. Consistently saving money over time – through both bull markets and bear markets – is a very effective investment strategy. While you can’t control what the markets are going to do, you have full control over your own personal cash flow decisions. Determine a realistic savings rate and gradually increase that amount over time as your income grows.
Your Investment Allocation:
Maintaining a diversified portfolio (stocks/bonds, value/growth, domestic/international, large-cap/small-cap) is a valuable approach to combating market volatility. Rather than trying to guess which markets are going to do well in the short-term, maintain exposure to all of them and benefit from their long-term growth over time.
Your Behavior and Commitment to a Strategy:
This is sort of a combination of your Savings Rate and Investment Allocation. Understand that market volatility is an inherent part of the investing process. You don’t get the benefit of growing your money over time without the short-term risk that it will occasionally lose value. There is overwhelming data and evidence on the best practices for successful long-term investing and making decisions out of fear and emotion rarely serve anyone well. Recalling the big picture and “why” you’re investing is important perspective when riding out market volatility.
You can always control your investment costs. Buying expensive investments, paying high fees and incurring unnecessary commissions simply means that less of your money can grow over time. Technology has completely transformed how we can invest today and that means access to incredibly inexpensive – but highly productive – investment vehicles. Understand what you are paying for and keep your costs as low as possible. While seemingly insignificant amounts (like 0.5%) might seem like small costs, they can collectively be a significant drag on your performance over long time horizons.
The tax efficiency of an investment portfolio is a very underappreciated aspect of successful investing. Investors can do very well by simply locating certain type of assets in different accounts. For example, tax-inefficient assets that generate income (such as bonds and REITs) should be emphasized in tax-deferred accounts like 401(k)s and IRAs, while more tax-efficient assets should be placed in taxable brokerage accounts. My colleague David Webb wrote about this topic earlier this year. Also, frequent trading within the portfolio generates tax bills that reduces how much of your portfolio can grow over time. Just like controlling costs, simply being mindful of taxes has shown to significantly improve investment performance over time.
Market volatility can be scary. It is never predictable and completely out of your control. Understanding this aspect of the financial markets is an important first step in combatting short-term market swings. Your behavior during these times will ultimately determine your long-term success as an investor. Focusing on things you can control is a much more effective strategy than worrying about the things out of your control. Keeping that perspective in mind will serve your emotional and economic interests best when Mr. Market goes through his periodic temper tantrums like we’ve seen the past few months.