The markets continue to take investors on a bumpy ride with dramatic swings to the positive and negative. Volatility has been here for the last several weeks and it is beginning to have an effect on investors and the decisions they make in regards to their portfolios. Investors are notorious for putting their portfolio on cruise control when the markets are doing well and then becoming hyper-sensitive when negative returns start appearing on their monthly statements. With the first true market correction (-10% or more) in nearly four years, investors are considering a variety of options with their portfolios, many of them misleading and possibly disastrous. As fear and uncertainty build emotions begin to take control. There are many products and options that prey on investors in these environments…don’t allow yourself to fall for any of the five most common ones we discuss below…
Going to Cash – This is the classic move by investors when they simply can’t take it anymore; throwing their hands up in the air and admitting defeat by selling everything and going to cash. They justify it in their mind, feeling good about it; after all, jumping out and preserving what was left of their portfolio seems like the prudent thing to do. If this is you or you are considering this ‘strategy’ don’t start patting yourself on the back just yet! This could possibly be the worst move an investor could make unless they want to push back their retirement or drastically alter their financial goals. Consider this, every year for the last 35 years the markets have posted negative returns at some point during the year and 87% of the time the markets finished the year positive. Selling everything in your portfolio would be comparable to buying a new car and selling it as soon as you drive it off the lot because you realized that it went down 20% in value! Would you ever do that? We doubt it so don’t do this with your investments!
Annuities – Simply put…Fear sells! Annuities are sold by insurance companies and push their products by using the word ‘guarantee’ frequently, especially during volatile markets. Turn on any financial station and you are sure to see ads for annuities during the commercial breaks. JD Mellberg is currently running ads with an attractive young woman stating, “It can only go up and can never go down.” We aren’t going to argue that fact as she is correct but she does leave out a couple key pieces of information. If the market is up 20% an annuity would typically deliver a return of around 10% (approximately half of the total return). They can provide protection in negative markets but remember this accounts for only 13% of the markets over the last 35 years! Annuities can make sense but they should never be viewed as a one-stop solution. Keep this fact in mind – investors don’t usually buy an annuity but rather they are sold an annuity. Brokers typically make around 5% to 7% selling annuities and their ‘guarantees’, don’t buy the hype!
Extreme Bargain shopping – We’ve addressed this issue several times, when the markets present investors with a textbook correction that is the time to work on your ‘shopping list’. The trap that many investors fall into is looking for stocks that are priced at what appear to be extreme discounts. The story happens far too often. A hot stock with a compelling story drops in price making it appear even more attractive yet the stock never recovers and is eventually acquired or declares bankruptcy leaving investors with nothing.
Just last year GT Advanced Technologies (GTAT) was considered a ‘hot stock’ as it was rumored that they would be rewarded with a lucrative multi-million dollar contract to provide the glass screens for Apple (AAPL) products. Jim Cramer loved this stock and touted it several times. The stock traded up to $20 per share and then it began to drop and kept dropping…all the way to zero. Instead of holding the next great stock investors where left with a total loss to carry against future gains. If something seems too good to be true chances are it is!! View corrections as an opportunity but don’t fool yourself into looking for the Picasso painting at a garage sale scenario.
Chasing yields or dividends – “Moderation in all things” – Keep this in mind when looking at dividend yielding stocks and even fixed income positions. There are many solid companies that are fundamentally sound and offer their shareholders an attractive dividend. A yield of 3% – 4% is attractive in this market environment especially when you consider the 10-year treasury is paying around 2%. When you can capture the upside of a quality company and be rewarded with a healthy dividend it can be considered a win for any portfolio. Where this can turn disastrous is when investors get greedy and begin ‘chasing yields’. A name that often pops up when running a search is the telecom company Windstream Holdings (WIN) it boasts an attractive 9.5% dividend. Who wouldn’t want that type of yield? Investors don’t have to dig very deep to realize the company has posted negative earnings per share along with negative cash flows. A business model like this is simply not sustainable and a few dividend payments will not be able to make up for the loss of principal. (Year to date WIN is down -87%).
Doing nothing – Many investors are surprised when they realize that doing nothing is actually doing something. While this ‘strategy’ is certainly not as devastating as selling everything it can have a dramatic impact on a portfolio. If an investor does anything in a volatile market, it should be to periodically rebalance their portfolio. The act of selling the best performing positions and buying the underperforming positions will allow their portfolio to remain allocated properly and emerge intact from the volatile markets and in many cases outperform. Research has proven that a portfolio’s allocation accounts for more than 85% of the account’s total returns; it isn’t stock selection or timing as many would think. “Doing nothing” sounds lazy, but just like fixing a leaky roof in the middle of a rainstorm, overhauling your entire portfolio in the middle of a market correction isn’t always the wisest choice.
Investing and planning for the future is an emotional process. The key is to not allow your emotions to be the driving force in the decision-making process. Fear and greed are NOT investment strategies!
Here are some tips to consider if you find yourself at a bit of a crossroads with your investments:
- Be honest with yourself and your advisor when discussing risk tolerance.
- Create a financial plan to focus on your long-term goals.
- Periodically review and update your financial plan to account for changes in your financial picture.
- Never act in haste.
- Don’t sweat the small stuff – tune out the media and focus on the big picture.
Volatile markets can make or break a portfolio. Will you allow yourself to become another
victim of Mr. Market or will you emerge from it stronger and financially sound?