Financial market volatility can spook investors. And while shifting to a defensive posture may seem like the right thing to do, you need to carefully consider your options before taking drastic action.
When markets decline, investors experience a range of emotions, and that can trigger an irrational response. Agitation appears as the market begins to dip, followed by distress, despair and finally, dejection.
Somewhere on that downward spiral, strong long-term investments with great potential are abandoned in favour of safer alternatives that barely keep up with inflation. Yes, there’s some relief, but it’s often short-term and won’t make up for the long-term damage done to your portfolio.
Staying out of the markets means that your money is sitting on the sidelines in cash or short-term instruments. While there’s a place for cash in a balanced portfolio, by no means should it make up the bulk of your holdings. And while you’re on the outside looking in, your long-term personal rate of return can be dramatically affected.
For example, an investor who stayed fully invested in the S&P 500 Composite Index from January 1, 1990 to December 31, 2018, realized a 7.0% annual return (excluding dividends). Conversely, an investor who missed the 50 best days of the S&P 500 over that same time period realized a -1.3% annual return (excluding dividends). That’s just 1% of the total trading days.
When economic signals point to a possible recession, you should consider taking steps to protect your portfolio, particularly if you are nearing retirement. As well as staying invested to take advantage of buying opportunities, you should build your emergency fund and examine your expenses.
A three- to six-month cash cushion is recommended even when times are good. In a recession, it’s practically a necessity as you don’t know what the future holds in terms of job prospects and other income sources.
As for your daily expenses, living below your means is a sure-fire way to gain financial freedom. One way to accomplish this goal is to create a budget and stick with it. In a recession, you might need to find ways to tighten your belt.
Of course, a well-constructed financial plan takes every outcome into consideration. Such a plan is purpose-built to handle the vagaries of the stock market because it reflects your risk tolerance.
In the face of volatility and talk of a recession, you should stay calm and stick to your financial plan, while continuing to fund your long-term investment objectives, such as retirement.
Speak to a financial planner who has experienced economic instability and can coach clients through volatile periods in the markets. Remember that investing based on emotion leads to one thing: regret.
This is a general source of information only. It is not intended to provide personalized tax, legal or investment advice, and is not intended as a solicitation to purchase securities. Dwayne Rettinger is solely responsible for its content. For more information on this topic or any other financial matter, please contact an IG Wealth Management Consultant.