How to Navigate Stock Market Volatility like a Pro
by Rachna Bijlani, CFP®
June 30, 2020
Stock market volatility is inevitable. Volatility becomes more pronounced during periods of uncertainty, such as election time, or one caused by the recent pandemic. This roller coaster can have an emotional impact on the strongest and wisest of minds, leading to poor judgement when making financial decisions. Investing is more than merely picking a particular stock; it warrants the ability to analyze, plan, and most importantly, block out the noise and emotions and focus on what’s relevant. This becomes increasingly difficult during stressful times when we are already concerned about the health and wellbeing of our loved ones. Let’s reflect on some poor investment decisions made by investors during times of volatility and figure out ways to avoid making these mistakes.
Panic selling - Pulling out of the market is a very common investor reaction during a downturn. In my experience, many investors eventually regret their decision of jumping the gun too soon. Market pullbacks are normal, and history has proven that over time, markets have recovered from their lows and delivered long-term gains. Unfortunately, most investors who end up liquidating their assets out of panic during a downturn have a harder time catching up. Emotions and behavioral biases can sometimes lead investors to act in a self-sabotaging way. Over-reaction to a piece of news or information can trigger a sell-off, and human tendency to follow the herd can add more fuel to the fire. Loss aversion drives investors to the edge, and the inherent need to take any kind of action in a dire situation, which gives us a false sense of control, acts as the last straw, causing investors to panic sell.
Staying objective and keeping your emotions in check are the pre-requisites of a being successful investor. However, this is easier said than done. After all, we are humans with emotions, which go into over-drive in an uncertain situation. The best way to control our mind and consequently control our actions is by shifting its focus. Instead of focusing on short-term volatility, focus on your long-term financial goals to keep things in perspective. If you are invested in a well-diversified portfolio which is in alignment with your time horizons, risk tolerance, liquidity needs, and financial goals, you should have little cause for concern. However, if you’re not confident in your current portfolio allocation, consult an investment adviser to determine the best course of action for your specific case instead of blindly following the herd. Remind yourself that downturns are normal, and historically, markets have always recovered from these phases. Channelize your impulse to take action and control the situation towards rebalancing your portfolio instead of liquidating it. Bring your asset allocation to its pre-determined percentages by selling some of the assets that have appreciated and buying the ones that have gone down in value. This will allow you to buy low and sell high, while maintaining your asset allocation. In Yoda's words, “Control, control, you must learn control!
Trying to time the market - Unless you have a crystal ball that can gaze into the future, it's practically impossible to accurately time the markets on a consistent basis. And yet, there are investors who believe they can successfully get in and out of the market while maximizing their portfolio returns. Overconfidence and hindsight bias can be detrimental to portfolio performance over the long haul. It can lead investors to inaccurately believe that they can avoid the downside while fully capturing the upside of the market. Instead of trying to time the market, pay attention to economic indicators and make adjustments to the asset allocation and sector exposure in your portfolio accordingly, before the actual event, not in the heat of the moment. A good strategy is to stay invested while lowering the Beta of your portfolio at the peak of an economic cycle and gradually increasing the risk in the portfolio towards the end of a recession. Remind yourself of the tax consequences of frequent and excessive trading. Look up data on how missing out on even a few best days in the market can significantly impact the overall performance of your portfolio. Let this line from the Bhagavad Gita guide your actions, “For those who have conquered the mind, it is their best friend. For those who have failed to do so, the mind works like an enemy (6.6).”
Buying a stock that you might think is now “cheap” - Focusing on the market price of a stock alone is a rookie mistake. The intrinsic value of a stock is the price a rational investor would pay for the stock in anticipation of its future growth. Discounted cash flow models, asset-based models, and analyzing price multiples are some of the techniques commonly used by analysts for stock valuation. A stock would qualify as being “cheap” if its intrinsic value is higher than its current market price. Usually, if there are enough investors or analysts following a stock, there will be little disparity between both these values. However, in times of euphoric buying or selling in the market, there can be a significant shift in market prices of equities. Most inexperienced investors lack the expertise to recognize or compute the intrinsic value of equities and rely on sources like “water cooler talk” to buy or sell securities. This trading pattern can tentatively be detrimental to your overall portfolio’s design and performance.
Your investment portfolio should be a reflection of your investment goals, risk tolerance, time horizons and liquidity needs. Randomly buying an individual stock just because you heard someone mention that the stock is currently underpriced is akin to buying a piece of art just because it’s on sale, without first considering how the new artwork will fit with your existing home décor. To make things worse, if your knowledge of art is limited and you decide to make this purchase without first consulting an art appraiser, you might just end up with an unsuitable and worthless investment. Always ask yourself these two questions before making a stock purchase- “Is this new investment in alignment with my investment objectives?” and “Is the stock actually undervalued or is it just cheap?”. There might be days when you wake up in the morning with this line from Portugal. The Man’s song, “I’m a rebel just for kicks now” playing in your head, and you feel the impulse to be fierce; do yourself a favor and stay away from your brokerage platform that day.
Most of us are “normal” investors who experience emotions and exhibit behavioral biases that are driven by those emotions. Investment decisions made under the influence of emotions can have a negative impact on our long-term financial goals. The key to being a disciplined investor is to keep your focus on your goals. I’d like to end with this story from the Mahabharata, which iterates the importance of finding your focus:
Arjuna was an excellent archer training under the great Dronacharya. Dronacharya put all his students to test, asking them to take aim at the eye of a bird perched on a distant tree. Everyone except Arjuna missed the target. The teacher asked all his disciples what they saw while taking aim. Some said they saw the tree, some saw the bird, the branches, the person standing next to them, the apple on the tree, and so on. When Arjuna was asked what he saw, his response was that he only saw the eye of the bird.
Your financial goals are your “eye of the bird”. Block out the noise and stay focussed so you can hit your target!