As President Trump’s tariffs on foreign imports continue to attract strong reactions and retaliation from China, the European Union, and other US trading partners, the stock markets have displayed some reactions of their own. On Tuesday, June 19, the Dow dropped nearly 300 points (1.15 percent) and the S&P 500 lost about 11 points (.04 percent) after the president threatened another $200 billion in tariffs on Chinese imports if China follows through on its threated retaliation for earlier penalties announced by the president. And this comes in a year that has already seen three of the Dow’s biggest daily point drops in its history. The much broader S&P 500 index has had 27 trading days in 2018 when it has closed up or down by more than 1 percent. Volatility has been the main characteristic of the markets, so far in 2018.
Is it time to sell your stocks and buy US bonds—or gold? Are we headed for a market meltdown? These are the types of questions that many investors begin to ask themselves when the markets begin to exhibit the types of wild swings that we have seen recently. And it’s only natural. Volatility—especially when it’s downward—makes us worry about the safety of our investments. But the answer to the two questions above is almost always “no.” Reacting emotionally to market swings—either by panic selling or going on a buying spree—will typically not increase the value of your portfolio over the long term, and we know this because of solid, data-based research.
A recent report from Dimensional Fund Investing notes, “While it may be difficult to remain calm during a substantial market decline, it is important to remember that volatility is a normal part of investing.” The report further states that from 1979 to 2017, the average intra-year decline for the stock market was about 14 percent. No one wants their investments to drop by 14 percent, right? And yet, during that same period, returns for the full calendar year were positive in 33 of the 39 years. This indicates two things: 1) even a sizeable negative swing in the markets during the year does not guarantee that the full-year return will not be positive; and 2) volatility is very common in the stock market.
As the Dimensional Fund research (and many other market analyses) demonstrates, jumping out of the market when you feel scared and jumping back in when you feel eager almost always results in missing the majority of gains to be had. Efficient markets aggregate literally billions of pieces of disparate data every day in order to arrive at the “right” price for securities. On the other hand, the chance of an individual investor accurately analyzing that data soon enough to successfully anticipate the price movement of the market is—statistically speaking—zero. Can someone occasionally make a lucky guess that makes them rich? Sure. But do you want to bet your future financial security on luck?
Rather than making haphazard changes in your investments in response to market volatility, it makes much more sense to follow the recommendation of evidence-based research: form a long-term plan before the volatility happens and stick with it. There is no substitute for a well-designed strategy that reflects your individual goals and resources. Such a plan will help you stay in the market with an appropriately diversified portfolio that is optimized for your needs and risk tolerance. Or, as the Dimensional Fund report concludes, “By adhering to a well-thought-out investment plan, ideally agreed upon in advance of periods of volatility, investors may be better able to remain calm during periods of short-term uncertainty.”
Stay Diversified, Stay Your Course!