Embrace Volatility & Make It Your Best Friend
Last updated: 2/6/2018
Who wants the stock market to be volatile? Crickets. Volatility isn't good, right? Well, maybe it is. With a little discipline and some planning, you can take advantage of the next stock market correction. You can embrace the volatility and make it your best friend. I’ll explain some ways you can do that.
What kind of volatility should you expect from the stock market? Volatility and stock market corrections are completely normal. In fact, on average, a 5% correction happens about 3 times a year, and a 10% correction happens about once a year. It's just that nobody knows when or why they happen until after the fact. I can promise you, the broad US stock market will experience another 5, 10, 15, and even 20%+ correction at some point. By expecting market corrections like this, hopefully you won't panic the next time one occurs. And maybe you can even be prepared to take advantage of the next market correction.
Want some historical perspective? American Funds has a great piece that shows the history of past market declines. Here's the link: American Funds - What Past Market Declines Can Teach Us
So how can you take advantage of the next stock market correction? Here are three ways you could take advantage of the next stock market correction:
One - Increase Your IRA and/or Retirement Plan (401k, etc) Contributions during a Market Correction: The next time the stock market goes through a correction, consider increasing your IRA and/or retirement plan contributions. For example, if the S&P 500 has a 5% correction, consider increasing your 401k contribution by one or two percentage points. If the stock market pulls back 10%, consider increasing your contribution rate even more. If the market pulls back 15%, consider increasing your contribution rate even more. You get the point. When the stock market recovers, you can go back to your original contribution rate. This way, you are buying more when prices are cheap. Can you imagine if you had increased your 401k contributions through the 2008-2009 financial crisis? You would have been buying stocks at extremely depressed prices. And your current 401k balance would look all the better because of it.
Two - Timely IRA Conversions & The 2018 Tax Cuts: Remember my ‘Timely IRA Conversions & The 2018 Tax Cuts’ blog post? If you haven’t read this yet, check it out. Stock market volatility and corrections give you an opportunity to do timely IRA conversions. Without stock market corrections, you wouldn’t have the opportunity to do timely IRA conversions. So consider embracing the next stock market correction by doing a timely IRA conversion. Remember, timely IRA conversions might save you a significant amount on taxes over the life of your IRA(s).
(Click here to learn more about ‘Timely IRA Conversions & The 2018 Tax Cuts’)
Three - Buy the dip! Volatility can be good because it gives you an opportunity to "buy the dip". If you have cash that you’ve been waiting to invest in the stock market, a market correction gives you an opportunity to invest that cash at a lower price (buy low). You also have an opportunity to increase the percentage of investments you have in stocks (buy low), while decreasing the percentage of investments you have in bonds or cash. If you are a long-term investor, short-term market corrections should not matter to you. The broad US stock market has recovered from every correction in its history, no matter how big or small the correction. So with a little volatility and some patience, you can use this volatility to your advantage by "buying the dip". Many investors do the exact opposite of this. They sell in a panic when the stock market is going through a correction. Don’t do that. If you’re a long-term investor, consider “buying the dip”.
Importance of Asset Allocation & Risk Tolerance: Know your risk tolerance and don’t have more in stocks than you are ultimately comfortable with. With my clients, I set an appropriate range for their asset allocation based on their goals, risk tolerance, and/or time frame. For example, with a “moderate” investor, I might set an asset allocation range of having 50-70% in stocks and 30-50% in bonds/cash, with the total always equaling 100%. This gives me the potential flexibility to “buy the dip”, as long as the client isn’t at the absolute high end of their appropriate asset allocation range. Make sure you have a discussion with your financial advisor about what asset allocation is appropriate for you.
Discretionary Authority and why it matters: Discretionary authority allows your financial advisor to manage your investment account, without discussing every trade with you in advance. This is important because it allows your advisor to be more pro-active…and possibly “buy the dip” for you during the next stock market correction. This is likely a key reason you are paying your advisor, to help manage your money and make changes when they feel changes are helpful. Have you ever wondered why your financial advisor isn't more pro-active when managing your money? If your financial advisor does not have discretionary authority, they may choose not to make changes in your account, even if/when they deem a change might be helpful, because they don't have the time to call all their clients to recommend the change. When you are working with an advisor who has discretionary authority, this isn't a problem.
Active management with low-cost passive index ETFs: In a separate blog post, I talk about using low-cost passive index ETFs. But how does a passive index ETF portfolio work with an active “buy the dip” strategy? Let me explain. You can still actively trade and rebalance low-cost passive index ETFs in your account. With this approach, you receive the benefits from both: Low costs and active account management. The two actually work quite well together.
(Click here to learn more about low-cost index ETFs)
What if the stock market doesn’t recover from the next major correction? I believe it will. And if you are going to be “buying the dip” or increasing your retirement contributions, you need to believe the stock market will recover too. For me, it’s very simple. My confidence in the stock market comes down to two key factors: Population growth and inflation. As long as we have population growth in the world and any level of inflation, it means companies will sell more goods and/or services to more people (population growth) at slightly higher prices (inflation) in the future. When this happens, corporate profitability should increase. When corporate profitability increases, this should ultimately lead to higher stock prices over the long-term. So as long as these two factors (population growth and inflation) exist, I believe the stock market will always recover. And remember, the broad US stock market has recovered from every correction in its history, no matter how big or small the correction. (Please note: Make sure you have an asset allocation that is appropriate for your situation. Even though the stock market has always recovered, the recovery doesn’t always happen quickly. Most corrections in the past have been relatively short-lived, but in some cases, it took many years before the market fully recovered.)
When do you NOT want volatility? As noted above, market corrections can last for many years before the market fully recovers. So if you're at or nearing the point where you will be withdrawing money from your investment account, you probably don't want your account to be too volatile. Why? Because you might not have enough time to recover from the losses. Make sure you have a discussion with your financial advisor about what asset allocation is appropriate for you.
What does Warren Buffett say? Warren Buffett is considered by many to be the greatest investor of all time. One of his most famous phrases is, "Be greedy when others are fearful, and fearful when others are greedy."
HyLine Bottom Line: The broad US stock market has recovered from every correction in its history, no matter how big or small the correction. With a little discipline and some planning, you can take advantage of the next stock market correction by increasing your IRA and/or retirement plan (401k, etc) contributions, doing a timely IRA conversion, and/or "buying the dip". You can embrace the volatility and make it your best friend.
What can I do at HyLine Wealth to help you embrace volatility? I will help you "buy the dip" and also help you reduce risk when the stock market is at or near an all-time high. For example, when the S&P 500 has a 5% correction, I may increase the percentage of stocks/equities in your account by approx 5%, up to a certain maximum percentage based on your goals, risk tolerance, and/or time frame (Side note: Some of my clients even look forward to stock market corrections so I can “buy the dip” for them). I also take on the responsibility of discretionary authority, which allows me to be more pro-active when I deem investment changes are helpful to you. And anytime I make a change in your account, I will notify you via email, along with a brief explanation of why I made the change. This email will also include suggestions, such as increasing your IRA and/or retirement plan (401k, etc) contributions and/or doing a ‘Timely IRA Conversion’. As I mention in a separate blog post ('Benefits of Index Exchange Traded Funds'), Schwab waives their commission charge when I trade/rebalance using their low cost Schwab index ETFs, so you don’t have to worry about this additional cost because it’s waived. Bottom line, I will help you embrace stock market volatility and make it your best friend. And I believe you will benefit from this approach.
Want more investment "tips"? We have a lot more great ideas and suggestions to help you be smarter with your money. CLICK HERE to get these "tips".
Questions? Don’t hesitate to reach out. If you have questions on anything, feel free to email me at brock@hylinewealth.com or call me at (605) 275-2343.
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Brock Hyde
Investment Adviser
brock@hylinewealth.com
HyLine Wealth
221 S Phillips Ave, Suite 207
Sioux Falls, SD 57104
Office (605) 275-2343
Location-Independent: Pretty much wherever you are located, we can work together. I am registered in the state of South Dakota and have an office in Sioux Falls. The “de minimis exemption” allows me to do business in most other states (with only a few exceptions). I consider myself "location-independent" as I use a heavy dose of technology to communicate and serve you. This includes screen sharing technology, electronic signatures when possible, and shared client portals so we can view the same information at the same time. Frankly, I can probably offer you better service than your "local" financial advisor.
HyLine Wealth is an investment advisor firm registered in the State of South Dakota. We do not provide tax or legal advice. Past performance is no guarantee of future results. Always consult your financial advisor, tax advisor, attorney, and/or insurance agent before implementing any specific strategy to make sure it is right for you and your unique situation. We are not responsible for the accuracy or upkeep of information on the links we provide to outside websites. If/when we provide a link to an outside website, be sure to independently confirm the accuracy of any information.