NEW YORK (MainStreet) —Despite the recent market slide, investors need to avoid making rash decisions because volatility is a positive sign that equities will yield higher returns in the long-term, said Edison Byzyka, vice president of investments for Hefty Wealth Partners in Auburn, Ind.
Downside market volatility is not only “an important aspect of well-functioning financial markets,” it is also “nothing short of expected normal market behavior that needs to occur,” Byzyka said.
A lack of pullbacks in the stock market results in the absence of capital for opportunistic investments "nor would the concept of money flow from stocks to bonds ever occur and vice versa," he said.
Investors need to refrain from selling their equities and should instead use their extra cash from CDs or savings accounts to purchase them at discounted prices, Byzyka said. Instead of viewing the market correction as an opportunity to buy cheaper stocks, many investors are motivated by fear and tend to sell their equity holdings.
“If retail investors were fully invested going into the correction, the last thing they should do is pull money out,” he said. “The startling truth is that equities are the only thing that retail investors hate purchasing when they become cheap. They wouldn’t hesitate to purchase their car if it drops in price by 10% tomorrow, yet they won’t purchase equities.”
A correction is actually good for the market but often produces a negative outcome for investors, because instead of sticking to a “well thought out strategy,” they use their emotions to make impulsive decisions, said Matthew Tuttle, portfolio manager of the Tuttle Tactical Management U.S. Core ETF in Stamford, Conn.
“It is awful for investors because when people are scared, they tend to do stupid things with their money,” he said.
Volatility is beneficial for the market, because it does not “go up in a straight line,” Tuttle said.
“The larger the correction, the bigger the rally can be,” he said. “We have been locked in a trading range all year, so this could knock us out of that.”
The market will continue to produce additional volatility due to China’s slowdown, Greece’s continued economic issues and other geopolitical concerns, Byzyka said.
“We’re in a stage of the U.S. equity market that has severely lacked downside volatility and is on a record three year stretch of calm, he said.
Dollar Cost Averaging for Your Retirement
The easiest and simplest approach to the market volatility is to continue dollar cost averaging or making consistent monthly contributions to your 401(k) or IRA. Investors who have extra cash should consider increasing their contributions over the near term and allow their investment plan to “materialize over the long-term with no significant deviations on your end,” Byzyka said.
Instead of viewing the dip in the market as a chance to buy stocks at a large discount, investors who panic and sell their stocks and sit in cash until the market stabilizes are “their own worst enemy,” said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa. Too many individual investors tend to buy high and sell low in an attempt to time the market.
“Their behavioral biases cause them to underperform market averages by a substantial amount,” he said. “They get fearful and greedy at exactly the wrong times.”
Another fallacy for many investors is to suspend making contributions to their retirement portfolios until they believe the market has stabilized, Johnson said.
“Trying to time the market requires an investor to make two decisions - when to get out and when to get back in,” he said. “Making one good timing decision is tough. Making two good decisions is a Herculean task.”
The focus should be on adding investments to their portfolio, because they will have an opportunity to buy at a lower price.
“The best strategy for an individual investor is to continue to do dollar cost averaging in a diversified equity index mutual fund,” Johnson said.
Individual investors have always found it challenging to grasp that volatility is actually “beneficial” for them, and the market pullback should not change their investment strategy, he said.
“Stocks are one of the only markets where when the price of something falls, people look at it negatively,” Johnson said. “In other words, when the price of Apple falls 20%, people want to sell it and when the price of Apple rises 20% they want to buy more.”
The correction is healthy for the market, and the sharp selloff will force investors to deal with the “higher risk of investing in stocks compared to fixed income,” said CJ Brott, founder of Capital Ideas, a registered investment advisor in Dallas, Texas and a portfolio manager at Covestor.
“Individuals are kept from creating speculative bubbles such as developed recently in China or in the U.S. in 1999 to 2000,” he said. “This keeps investors investing rather than speculating on short term fluctuations in markets.”
China’s slowdown has contributed to the massive correction, but “we won’t fully know the catalyst of this correction for another three to six months,” Byzyka said.
Expecting that markets will always act rationally is a folly along with the idea that “we should know exactly why volatility has emerged,” he said. “In any case, the correction is healthy and it is warranted given the lack of volatility over the past three years,” he added.
Investors must change their sentiment toward the market and view the correction as a necessary and positive occurrence, said Johnson.
“People are certainly fearful now,” he said. “Those who ‘stick to their guns’ will be happy in the long run. Those who capitulate and sell out will likely buy back in at a higher level and will have an opportunity loss.”