How to Behave in Volatile Markets

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I wrote the article below at the end of 2011. As you may recall, the general market was down 9.41% (MSCI All Country World Index USD). The message of this article is just as important now as it was in 2011. 

With record highs this year, investor sentiment is at a high as well. That said, it is very important to stay steadfast in your long-term investment plan. Regardless of the extreme (lows or highs), it is not the time to make changes to your investment strategy in reaction to what the market has done. Nor is it the time to make changes in anticipation of what you think the market will do. 

“Staying the course” may sound like a boring investment strategy, but it is the responsible one. I (and our clients as well) pick responsible over boring any day. 

If we have learned anything from the market in the last decade, it is that the market is volatile in the short term. In order to successfully navigate through the uncertain times, we believe that there are 3 Principles and 3 Practices that investors should adopt to ensure superior, long term returns.

Principles

1. Faith – have faith in the market; have faith in growth over the long term.

2. Patience – investors often feel “beaten up” or depressed by short term market volatility. Do not react to short term volatility.

3. Discipline – to maintain your original investment plan. Whether it mean remaining invested in a strategic asset allocation or setting up a periodic contribution plan. You must be disciplined in all market conditions.

Practices

1. Asset Allocation – ensuring that your portfolio has a suitable amount of exposure to risk/growth assets and conservative/safety assets, appropriate to your tolerance for volatility.

2. Diversification – ensuring that the investments in the specific asset classes are spread out amongst many, to mitigate any one investment’s risk. By incorporating this practice, you deny yourself from ever making a fortune in the market but, at the same token, you prevent yourself from losing a fortune in the market.

3. Rebalancing – ensuring that your portfolio maintains its target asset allocation. The market is dynamic and will cause your portfolio’s asset allocation to deviate from its target mix over time. By periodically selling what has performed well and buying what has not, you can lock in gains (i.e. age old adage, “buy low, sell high”). This is an automatic practice that does not rely on inconsistent market timing.

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