2023: What you need to know about market volatility and your investments
The S&P 500 finished 2022 with a 18.1% loss, marking the seventh worst loss since the 1920s. The bonds market also had one of its worst years in history. Since the 1920s, there had only been one double-digit calendar year loss for the 10-year US treasuries — until 2009 when there was a 11.1% loss. In 2022, the US government bond benchmark was down by more than 15%, making it the absolute worst year for the bonds market.
A 60:40 portfolio of US stocks and bonds was down by more than 16% in 2022, making it the third worst year for diversified portfolios. If you had skin in the game, 2022 possibly would have been one of the worst and toughest years an investor could ever experience.
Going into 2023, the Federal Reserve is committed to fighting inflation, expecting higher interest rates to remain in place until more progress is made. Weighing on investor sentiments is mainly a two-pronged policy risk. First, the Fed does not keep rates high so as to allow inflation to fester, like what was experienced in the 1970s. Second, the Fed keeps restrictive policies in place for an extended period of time, hampering the economy “too much”.
Market uncertainty can naturally cause panic and lead to poor investment decisions. Here are five tried-and-tested tips that can help you gain perspective and improve your assessment and investment decisions:
1. Maintain your long-term focus
Over the years, investors who have remained disciplined and focused on their long-term investment plans have been well rewarded for their patience.
A study done by Dalbar in 2018, which examined the average returns achieved by investors across a 20-year period, found that when investors tried to time the market, they significantly underperformed the market index. Over that period, the average investor underperformed a simple, indexed 60:40 portfolio by 3.5% annually.
History has repeatedly shown that time in the market is the primary driver for investment growth.
2. Dollar-cost averaging
When you automate investing a fixed dollar amount on a regular basis, it is a builtin form of discipline that can help you avoid second-guessing your long-term plan. In the face of volatility-induced stock and index declines, dollar-cost averaging offers an opportunity for long-term investors to reduce their average share cost.
Dollar-cost averaging is when you invest the same amount of money in a particular security recurring over a certain period of time, regardless of price. If the price of the security declines, your same monthly investment can buy a greater number of shares.
3. Don’t put all your eggs in one basket
Diversification is a technique that mixes different types of investment asset classes in a portfolio in a bid to lower correlation risk. By including investments that react differently to various economic and market events, the gains of some asset classes will help to offset losses in others.
Asset allocation, on the other hand, is the act of dividing your investments among different assets such as stocks, bonds and cash. How each investor divides the pie is largely unique to his/her financial goals and risk appetite.
Therefore, it is crucial to further diversify within each asset class. For example, if you are investing in the bond market, do ensure that your bond portfolio is not entirely concentrated in just one specific area such as the US treasuries.
4. Have cash on hand
It is ideal to have sufficient cash in your savings account to cover six to 12 months of your expenses (the exact amount would depend on your personal situation). This emergency fund will help you tide over an unfortunate event such as a job loss or an unexpected expense like a large medical bill, reducing the risk of needing to sell stocks at a low point.
Savings accounts are now offering better rates than what we have seen in the last decade, with some as high as 4%. Although that might seem extremely attractive, we advise investors to make a conscious effort to pay down their higher-interest debt, such as credit cards and car loans, as much as possible. The goal is to reduce as many financial stressors as possible when markets turn volatile, so that you are less likely to fall prey to your emotions and better able to avoid impulsive, poor financial decisions.
5. Review and rebalance
Rebalancing is the process of buying and selling assets in your portfolio to maintain your asset allocation. For example, you want to have a portfolio that is 60% stocks and 40% bonds. If the stock market experiences a major change such as a 20% decline in 2022, your portfolio may tilt away from your planned allocations, with equity allocation dropping below 60%. The aim here is to bring your equity allocation back to 60%.
Rebalancing your portfolio is important because the weightage of each asset class changes over time, altering the risk profile of your portfolio. It is prudent to ensure that your portfolio is composed in a manner that adheres to your investment strategy and risk profile.
Rebalancing your portfolio will help maintain your original asset-allocation strategy, giving you the flexibility to make changes to your investing style when necessary or desired. Essentially, rebalancing will help you to stick to your investing plan, regardless of what the market does, and maintain your risk tolerance levels.
Remember that market volatility comes and goes. When you are armed with a properly diversified, long-term portfolio and anchored in a comprehensive financial plan, you feel more confident in staying on track towards achieving your long-term goals. Seeking the help of financial professionals to partner you for the long haul can further help you by reviewing your financial plan, navigating rough waters with you, and ultimately achieving your investment goals together.