Following some recent market volatility, an investor asked me, “If there is a stock market sell-off and money is withdrawn from the market by an exodus from ETFs/mutual funds, what investment strategies can one use to protect him/herself as fundamentals will not matter?”
My answer to that question can probably help many investors clarify their investment strategies and find productive ways to deal with stock market volatility.
The vast majority of stock investors are going to experience big drops in portfolio values during bear markets or market corrections, and there isn’t too much that we can do about it. Most investors, due to a combination of factors, end up selling near the bottom and missing out on rebounds. So the key question becomes, “Are you brave enough to let your stocks recover in the coming months?”
There are a small percentage of stock investors who successfully use strict stop-loss disciplines, but I can’t recommend that style of investing to my broad subscriber base because very few investors really master the task. I know from experience that using stop-loss orders and mental stops are fine investment strategies that often causes investors a lot of angst.
Knowing in advance that our stocks will fall periodically, through no real fault of their own, here are a combination of investment strategies that I recommend:
- Stick with high-quality companies, so that when your stock falls dramatically, you can retain confidence in the company in which you’re invested. As a hypothetical example, “XYZ Company (XYZ) is an excellent, growing company, and the share price just fell 30% for no good reason. I will hold my shares and await the rebound.”
- Keep cash on hand, so that you can “buy low” during market downturns, thereby turning lemons into lemonade. “Wow, I’ve always wanted to own ABC Company (ABC), and the share price is down 25% this year. It’s now or never! Let’s buy some shares!” Having cash on hand is a great investment strategy that holds true for buying additional shares of the great stocks that you already own as well.
- I don’t sell high-quality stocks during market downturns. But I do move most of them from Buy to Hold recommendations during the obvious price drops. Then I move them back to Buy recommendations when the price charts seem to indicate that they’re going to rebound soon. And with dividend stocks, you can lock in quite an attractive yield during market downturns, which I frequently point out is a great investment strategy for maximizing income.
Over the short term, stock market action is driven by human behavior and news headlines. Over the longer term, stock market action is driven by corporate successes/failures and the economy. The more we are able to disassociate ourselves from the fear that emanates from short-term market moves, the more we’re able to sit back and ask ourselves, “How can I capitalize on this nonsense?”
The answer, ultimately, is to stay disciplined. The better we adhere to a system and buy stocks based on specific criteria and time-tested investment strategies rather than emotion, the better our portfolio performance will be.