Market corrections happen every few years. There are few things more painful for investors than to see a chunk of their life long savings just vaporize. However, what turns painful losses into a market crash is when people see others panic, and then everyone makes for the door. Historically, the investors who remain invested during volatile markets have significantly outperformed others who try to selectively enter or exit.
Here are six strategies that will enable your portfolio to withstand market volatility and to come out ahead in the long run:
1. Create a retirement plan
This will force you to prioritize your life goals, and enable you to make better decisions on who allocate spend your time, energy and money.
2. Diversify using broad index funds, and do not pick stocks
Index ETFs are low-cost and tax-efficient investment vehicles that provide broad diversification. Many investors are lured by gurus who profess to achieve high returns from hot stocks. Here's a million dollar tip: do not try to pick hot stocks. Active stock trading is a zero sum game, and the odds are stacked heavily against you. Most retail investors wind up losing against professional traders. The High Frequency Trading groups make billions in profits at the expense of retail investors. Furthermore, many "too good to be true" value stocks are the most likely to go bankrupt, potentially causing a 100% loss even while the overall market is going up! Plus, the more frequently you trade individual stocks, the more you pay in commissions and bid/ask spread costs. On the other hand, diversified index funds can withstand market shocks, and have far lower transaction and bid/ask spread costs.
3. Portfolio risk is transparent and in line with your risk tolerance
Only invest in a portfolio of which the risks are transparent to you. You should choose the risk level of your portfolio such that you can withstand its worst-case losses. This way even if the market crashes, your losses are likely to remain within the boundaries of your risk tolerance. Hence you will be less inclined to panic and sell out at the bottom. Try to use measures of loss that you can understand like Value at Risk or maximum drawdown during the financial crises of 2008.
4. Do not try to time the equity market
No one can predict the market's movement. Many times, the large up moves happen during periods of weak corporate earnings, dismal economic news or when investor sentiments are negative. Investors have to remain in the market to take advantage of big growth spurts. Many "conservative" investors like to watch the market from the sidelines and invest after the market goes up. Such S&P 500 index investors who missed the 12 best "upmarket" months of the last two decades, saw their cumulative return slashed from 264%, to just 36%.
5. Consider a hands off approach - Use automated rebalancing
According to behavioral economists, the more frequently you look at your investment account, the more tempted you will be to actively trade or time equity markets and subsequently make bad investment decisions. Instead, you can do better by having a reasonable global portfolio strategy that automatically rebalances your investment account.
6. Automate deposits into an investment account
People who save systematically into pre-tax and post-tax investment accounts, wind up much further ahead than others who don't. Research shows that once cash enters an investment account, people treat it with reverence and are less likely to spend it on frivolous things. Also, most people who save cash in the checking accounts are too tempted to spend it on things without considering the long-term opportunity costs of their actions.
To find out what strategies are suitable for you, please visit RazorHedge.com or contact us at 312-488-4874
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Team Razor Hedge is part of Razor Hedge Investment Management LLC, a fee only independent investment advisor registered in the state of Illinois. This article was written by Muzzamil Mussani, CFA, Portfolio Manager. We did not receive compensation for this article (other than provided by Seeking Alpha for original content), and we have no business relationship with any fund or company whose stock is mentioned in this article. The article is for educational purpose only and should not be taken as a recommendation to transact in any specific security. Discuss with your advisor to check if the strategy or securities mentioned are appropriate for your specific situation. Razor Hedge may hold positions in securities mentioned in this article on behalf of our clients.