When the market experiences volatility, investors can get caught up in a vacuum of bad news. The slightest news can swing investor sentiment. It could be a real concern, such as the confirmation of an administration that favors higher taxes, or it could be as slight as a weekly economic estimate coming in lower than expected. When the market gets crazy, investors react because they see so many others reacting. If blue chip stocks traded to the downside, panicked investors may follow suit, driving down the price more.
When you see such volatility, you have to ask yourself, “Why?” If you cannot answer, or do not understand what is causing the fluctuations, your answer could be that you do not want to do anything differently.
While planning for higher taxes should begin now, investors should be careful to not make knee-jerk decisions. When you make investment decisions based on emotions, you generally will never win. If you are working with an adviser, know that they need to put time and effort into how higher taxes will affect your personal financial situation. Investment analysts need to research how companies operate and profit in countries with similar government mandates. Remember, the market is forward looking, and it may have predicted this outcome before the general population did.
When you began investing, you established criteria for your purchases and sales. For example, consider the following sell criteria: a change in the company’s long-term fundamentals, a change in the company’s business model or management structure, or a change in the company’s financial strength. When a stock’s price is plummeting, you examine the company to see if any events have triggered your sell criteria. You may find out that the decline in price is a result of normal market fluctuations.
The market drops 10 percent on average once a year, and has experienced this 124 times since 1926. If your portfolio falls 10 percent, it must increase by 11 percent to break even. Likewise, if it falls 50 percent, you need it to go up 100 percent to break even. If you earn only 1 percent a year after fleeing the stock market in favor of U.S. Treasury bonds, it will take you 70 years to break even.
There are many philosophies and strategies for investing, but the math does not lie. When the market’s fluctuations look like the choppiest of oceans, you should have your sell criteria to rely on. If you determine that a company’s stock is still among the highest rated, management is solid and the company’s financials are intact, your investment decision should be to do nothing.
You did not ignore the market, you simply came to the conclusion you need not do anything differently.