The major indexes all reversed their course and erased the massive losses from Monday with the S&P 500 remaining nearly unchanged during this volatile period. Instead of rushing to capture some of the losses they incurred earlier this week, retail investors need to be stalwart in their purchases of individual stocks or focus on increasing their monthly allocations of mutual funds or exchange-traded funds into their 401(k) or IRA.
Reacting too quickly after a large market gain can be a foolhardy decision, because too many investors fear missing out on a rally, which proves to be a “powerful bias,” said CJ Brott, founder of Capital Ideas, a registered investment advisor in Dallas and a portfolio manager for Covestor, the online investing marketplace.
“If a person had the mental discipline to have not reacted to this mania, then he or she is probably not too influenced by that fear,” he said. “They should use today to consider buying good quality stocks they have wanted to buy, but missed earlier in this year’s run up.”
A rally in the market is good for long-term investors, but “chasing this morning’s prices” is rarely a good idea, said Brott. Buying in the “mid-day afternoon swoon” is a better strategy, he recommends.
Employees who have the ability to increase their 401(k) allocations should make “slight upward increases in percentages contributions or allocations,” Brott said. “I would not go whole hog as the market is now fairly priced but not cheap,” he added.
Too many investors are guilty of falling prey to a behavioral finance concept called “recency bias,” which is the influence of the most recent events, said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa. Many investors fled the markets on Monday and even went as far as discussing disaster scenarios in which the Dow fell to 10,000 or even 5,000. Although the outlook for the financial markets and China were all “doom and gloom,” now the focus is on the strong GDP growth in the U.S. and the rally of global markets, he said.
In the span of less than a week, investors have now flip flopped and are now worried about missing the rally, Johnson said.
Increasing 401(k) contributions or adding to an IRAs is an even better idea in times of downside volatility, said Edison Byzyka, vice president of investments for Hefty Wealth Partners in Auburn, Ind. Leaving your emotions out of the equation means investors can make sounder decisions they will not regret in the future.
“If you were not able to get out at the top before the much needed correction, then getting out now is a very bad idea,” he said.
Following the herd can result in disastrous results since people who are panicking, even financial professionals could have different investment objectives such as making money when stocks decline, said Jimmy Lee, CEO of the Wealth Consulting Group in Las Vegas.
“Staying invested during downturns is the only way to receive market like returns,” he said. “Many investors who panic sell their equities near bottoms, because they get emotional and panic.”The short-term “vagaries” of the stock markets should be ignored and investors need to be disciplined in their investment strategy instead of trying to time the market, said Johnson. Following a “boring approach” of dollar cost averaging in 401(k)s and IRAs yields better returns in the long run, he said.
“If one is not investing the maximum that they can in tax deferred accounts, I would strongly advocate that they increase their contributions and contribute as much as they are able,” Johnson said. “Investors need to treat their investing activities as a marathon and not a sprint. Daily or weekly moves should not alter one's investment discipline or strategy.”
Sectors To Allocate Money
Investors who have extra cash from CDs or money market accounts should tread carefully when they buy additional stocks or mutual funds or ETFs for their retirement portfolio.
Don’t sink all of your money right now in the stocks that you have wanted to purchase and instead buy them in increments, said Brott.
“I would buy 33% to 50% of what I wanted to purchase now and the rest later on in the next week or two if the market moves up and proves you right,” he said.
Cyclical sectors such as U.S. energy and technology could be the “best approach for upside participation given the relative weakness of those sectors for the past month,” said Byzyka.
International stocks might also be a good asset to include because of the losses they have experienced, making them likely to rebound.
“The valuations look healthy and attractive outside of the U.S. and it's an area that has not received much merit from investors over the past three years,” he said.
Commodities are an undervalued sector right now and purchasing a commodity ETF or mutual fund “takes some courage, but they have been beaten down,” Johnson said.
“With a rebounding economy, commodity prices should increase,” he said.
Investors should become tactical in their approach by purchasing momentum stocks, because they can “enjoy the upside while it lasts and still be able to protect themselves if we retest the lows,” said Matthew Tuttle, portfolio manager of the Tuttle Tactical Management U.S. Core ETF in Stamford, Conn.
“The best ETF is iShares Trust (MTUM - Get Report) and we have a 34% position in that in (TUTT) ,” he said. “The declines like we just had rarely end in a V shape and we will probably retest the lows at some point.”
Corrections have a tendency to reset valuations because the fundamentals of a stock “tend to get out of whack,” said Patrick Morris, CEO of New York-based HAGIN Investment Management. The increased volatility results in quality stocks that get caught up during a panic and become “really cheap and make for great buys,” he said.
“In some ways, a good correction has the same effect as a brush or forest fire,” he said. “Ideally, occasional small fires make the ecosystem healthier, but if you don't have them frequently enough the severity and the effects are more extreme.”
Morris recommends his favorite sectors of biotech and energy and to bypass the other commodities. Another strategy is to examine the one-year returns and “rotate to the most beaten up sectors,” he said.
“Obviously this is not foolproof, but you get the bigger upside when you look at beaten up sectors,” Morris said. “Once all that can go wrong is priced in, only a little positive news will inspire some really powerful rallies.”
Instead of focusing on individual stocks, look at buying ETFs by examining the worst 52-week performance and be wary of “very, very narrow sectors like coal and paper,” he said.
Investors have been both fearful and greedy this week and succumbing to emotional investing is “hazardous to your wealth,” said Johnson.