The S&P 500 fell more than 10% from January 26 to February 9. It was one of the sharper selloffs in recent memory. For many, the abrupt selloff raised questions such as… Do I stay in? Do I get out? When do I sell? What’s the plan?
We have no way of knowing whether or not the selloff in early February will be remembered as the beginning of a bear market or simply a sharp and sudden correction. Throughout the last 10 years we have seen several such instances for one reason or another (Greece, China, etc.) that amounted to little more than a temporary setback. However, we also feel that the market is expensive and in the later stages of a bull market; i.e. we don’t discount the possibility that it could be beginning of a bear market.
What should investors do? What are the different ways to handle the increased volatility? Here are some options.
Option 1: Do nothing.
For buy and hold investors with a long-term time horizon, the best path is often the simplest. If you like the investments that you own and you don’t anticipate needing to sell anytime soon, then simply staying put is often the best plan. Litmus test: were you investing in 2008? Did you panic then and sell? If you were able to stomach 2008 / 2009 without panic then you should likely do the same the next time around. Ignore the fluctuations, watch less news, and don’t be concerned about markets.
Option 2: Change your allocation now.
If the fluctuations in your portfolio in late January and early February made you uncomfortable, then you need to be proactive and change your allocations now. Don’t wait until later. The stock market is still within 5% of an all time high. Consider adding some fixed income and precious metals to diversify risk and reduce volatility.
Asset allocation is a function of time horizon, risk tolerance and the prevailing investment landscape. If any of those inputs change then the asset allocation likely needs to change as well. Be honest with yourself about how much volatility you can stomach.
Option 3: Have a plan in place to reduce risk.
This is the approach we take for the discretionary accounts that we manage. We can’t time the market, but we can have certain “trigger” points to attempt to reduce risk in a portfolio. For example, rules for risk management may look like this:
“If the six-month return for the S&P500 becomes negative, reduce equity holdings by 25%”
“If the 50-day moving average falls below the 200-day moving average, reduce equity holdings another 25%”
Also, we can use “stop loss” orders to reduce volatility on individual holdings.
“If Wal-Mart falls 8%, then let’s sell it.”
Having rules in place to help manage risk can be a powerful and helpful tool in investment management. Regardless of what camp you fall into (hold, re-allocate now, or rules-based) knowing yourself and knowing the plan is pivotal to long term investment success.
Please feel free to reach out to discuss the specifics of your risk management plan.