NEW YORK (MainStreet) — When major stock market indexes are sliding downward at bobsled-like speeds, the idea of profiting from the turmoil can seem far-fetched to a typical retirement saver who sees only prospects for loss. But volatility has two sides, and even ordinary retirement investors can gain when equity markets are volatile.
In times like these, managing investments begins with managing emotions. “First, breathe,” says Yvette Butler, president of Capital One Investing in McLean, Va. “Don’t get too caught up in the hype.”
It can help to keep volatility in perspective. “We’ve been in a bull market for about six years,” Butler says. “Markets just naturally contract at times.”
Since markets also naturally tend to recover from contractions, Butler advises investors to consider investing more while prices are depressed. “Make sure you’re allocated appropriately for your risk level and time horizon and, if you can, consider it an opportunity to maybe add to your portfolio,” she says.
One way to approach investing in a down market is as a portfolio rebalancing exercise. When values for a class of securities decline broadly, an individual retirement portfolio may get out of balance. If an investor wants to be 70% in equities and 30% in fixed-income, a 10% stock market decline may make the portfolio over-invested in fixed-income. Buying more equities can restore the appropriate balance.
Butler cautions against using volatility alone as a signal to rebalance, however. “If you had a plan to do quarterly balancing, I’d stick with it,” she says. “The problem with waiting until a correction to rebalance is that is, in essence, market timing, and we don’t recommend that. The data show over and over again that people who try to time the market end up with sub-par returns over the long-term.”
Time, if not timing, is a key factor for how younger retirement savers in their 30s and 20s should react to future downdrafts, however. “They should be 100% in equities,” says David Edwards, president of Heron Financial Group in New York City. “They should rush forward and buy more.”
The basic idea is that over the long-term equity values trend up and are more likely to out-pace inflation than fixed-income investments. So short-term dips in equities are buying opportunities.
When declines are broad-based, of course, identifying opportunities can seem challenging. Edwards says the best today are sectors where prices were declining before recent events. Those include energy, commodities and emerging markets. “That’s where we’d go first,” Edwards says. “We like to buy something that everybody else is selling.”
One caveat to Edwards's all-in advocacy is that this applies only to money that individuals won't need for many years, such as retirement funds for younger savers. Short-term price trends aren't major issues for investor funds that won't be needed for decades. With those funds, you don't worry about volatility Instead, the risk is that investment gains won't keep up with inflation. That's less of a risk with equities. “So the pot that has your long-term money has to be in equities,” Edwards says.
On the other hand, emergency funds and savings for specific upcoming uses, such as buying a home in the next year or so, should not be risked to volatility-prone equities. “If the purpose has a one-year time horizon, you can’t take any investment risk,” he says. “It has to be in cash.”
While gaining from volatility may not be easy or even viable for all investors or all accounts, advisors stress that the downdraft of an up-and-down market often presents opportunity for profit as well as loss. Many equities that were attractive to long-term investors before the volatility struck are more attractive now that they can be had for less money, says Adam Morgan, a senior investment advisor with PNC Wealth Management in Raleigh, N.C.
“The old adage that if you like a stock at 80 you love it at 60 holds true for long-term investors that can withstand volatility,” Morgan says.