NEW YORK (MainStreet) — Financial advisors tend to have differing opinions, but on the topic of yanking money out of the market when volatility strikes, they speak with nearly a single voice: don't. Sure, you want to cover your six, but you have to be rational.
“Don’t let something push you off course,” said Craig Brimhall, vice president of wealth strategies at Ameriprise Financial in Washington, D.C. “This too shall pass.” Similar advice is echoed by just about every financial advisor.
But on August 24, when the Dow Jones at one point was down a record-breaking 1,000 points, the advice was widely ignored. That day MassMutual, which serves more than 35,000 retirement plans and approximately three million plan participants, received more than double the usual number of calls, according to a spokesperson. Callers initiated four times as many balance transfers as normal, typically switching from equities into fixed-income – exactly that the experts warn against.
Advisors say there are a couple of reasons why staying the course during periods of volatility is a viable way to protect a portfolio. One is that, especially for younger investors who won't retire for decades, occasional sharp movements in share prices won't matter in the long run.
“When investing for retirement, remember that you should maintain a long investment horizon,” said MassMutual spokesperson David Potter. It is normal to have volatility, even occasional exaggerated swings, but investment decisions driven by fear and other emotions often turn out to be detrimental in the long run, advisors concur.
If you are making regular contributions to an IRA or 401(k) through payroll deduction, you should probably keep it up, Brimhall said. When prices are down, investing the same amount weekly or monthly buys more shares, driving down the average cost per share. This dollar-cost averaging is one of the most reliable ways to achieve solid investment returns. “It's not very exciting, but it's very effective,” Brimhall said.
If you have cash sitting on the sidelines, a market dip might be a good time to buy additional equities. Purchasing more shares in good companies and good industries can help build a bulwark against future volatility, especially when prices are down. “There are some values out there,” Brimhall said.
To spread risk when investing in a down market, consider broadly diversified mutual funds. These tend to move less rapidly up or down than individual shares. Low-beta shares or exchange-traded funds can also dampen future swings. Beta is a figure that shows how closely a security tracks an index like the S&P 500. A beta of less than 1, such as 0.9, indicates the price will tend to move less than the index. Health care, consumer staples and utilities are three industries with historically low betas.
Investors who have particularly low tolerance for risk could consider hedging with options. An options contract gives the right to buy or sell a security at a given price on a future date and can be used to limit downside risk. Sophisticated investors such as hedge fund managers also employ them to increase leverage and potentially improve returns, but individual investors generally find options too complicated and risky.
At Vest, a McLean, Va. company that provides an online platform for using options, users can select an individual stock or exchange-traded fund they want to hedge and purchase protection with an options strategy calculated by the platform. For instance, an investor might seek to limit losses to 10%. “This kind puts guardrails around a portfolio,” said Karan Sood, co-founder of Vest.
By automating options strategies, Vest seeks to make the technique available to ordinary investors. Sood emphasizes that for younger investors in particular, the simplest and most effective strategy for managing short-term volatility is just to ride it out. However, if an investor may need funds soon for a house down payment, for example, or is simply less risk-tolerant by nature, options may be suitable.
As a final word for handling volatility, Brimhall invokes the man who is arguably history's greatest investor. “Take the Warren Buffett approach,” he says. “Buy well and hold long.”