When the market experiences volatility, my phone often rings, and it’s always the same question, “Is it time to sell?” The catalysts might be different, depending on the type of investor. Some called in early February 2020 when the market reached a new all-time high. Others called in March when the market was down 34% because of the coronavirus outbreak. Then there are those who call now because they’re worried about the election outcome.
These reactions are emotional responses. Investors are worried about their money. However, part of working with a financial adviser is to take the emotional response out of your investment decisions. An investment manager or financial adviser is there to help you develop and achieve the goals in your overarching financial plan. They are not there to call you about a new stock or tell you that volatility will be high in the next 30, 60, or 90 days. They are looking at your money for the next 10, 20, and 30 years.
When an investor begins working with an adviser, they develop a plan to reach the client’s investment goals. Within that plan, you define your fundamentals in an Investment Policy Statement. This includes your target asset allocation, your investment strategy, and the circumstances in which changes can be made to your portfolio. The investment policy statement is designed to ensure that both sides understand the scope of the manager’s decision-making authority and the guidelines on which investment decisions will be based. This includes your sell criteria.
I believe investors should hold on to an investment as long as it meets their investment objectives. I recommend investing in companies with predictable earnings, serviceable debt, and attractive profitability. Fundamentally, you should sell when a holding falls below your criteria. Tactically, you may choose to sell when an investment no longer has the upside growth potential in its industry that its competitors have. You should also sell if there is a fundamental shift in a company’s strategy or when there are signs of management incompetence or dishonesty. However, your allocations among industry sectors should remain constant, replacing the out-of-favor stock with more favorable companies in similar industries. I encourage you to always maintain a diversified portfolio.
Having fundamental criteria for stock selection helps ensure you hold high-quality companies that have reliable earnings regardless of economic conditions. When you see moves like Monday, down 5%; Tuesday, up 4%; Wednesday, down 4%; Thursday, up 5%, you must ask yourself, “Why?” If you cannot determine why or do not understand what is causing the volatility, your decision could be that you do not want to do anything differently. Once you have a plan, stick to it.
When the market is up, I recommend selling equities to cover your spending needs; however, if you don’t need the money, it should remain invested for your long-term goals. If you follow the Ten Year Rule, any money you need in the next 10 years should be invested in fixed-income investments to protect the principal. When the market is down, you have the flexibility to wait up to 10 years before you need to sell. The market is inherently volatile, but the market will also eventually even out because fundamentals drive the stock market in the long term.