Has market volatility got you scared? I mean, in the past 10 months we’ve had five drops of ~7% or more … that’s Freddy Krueger (Nightmare on Elm Street reference) scary.
The Federal Reserve starting raising rates quickly and aggressively and then suddenly stopped – the market moves. President Trump tweets about it and the market moves. The China Trade War is not going to end soon and it’s only getting worse – the market moves. President Trump tweets about it and the markets move. Companies warn that future earnings will be lower, which sends markets down. When will the madness end?
This is the past 10 months in a nutshell. It take nerves of steel to hold onto stocks let alone buy even more. I’ll be the first to admit it takes a special state of mind to master the “art of calm” when all hell seems to be breaking loose in the stock market.
It’s only been a recent event where I have “mastered” any resemblance of calm during volatility. And by mastered, I mean I’ve stopped pooping my pants every time the market drops more than 5%. So I’m using the term “mastered” pretty casually here.
Please don’t get me wrong though, it still upsets me at times when it seems like the market is pounding away at only my portfolio. But now I try to use the volatility to my advantage, I know what my goals are, and I’ve got a plan that I’m diligently executing. Having a plan will help keep you focused and be less emotional, which is critical during volatility.
Investor Behavior During Volatility
For fans of the Seinfeld TV show, I think Season 5 Episode 22 (The Opposite) is very applicable to our situation. In this episode, George says that every decision he has ever made has been wrong, and that his life is the exact opposite of what it should be. And more important, I think Jerry’s advice might be something we should consider when it comes to stock market volatility.
“If every instinct you have is wrong, then the opposite would have to be right.”
Jerry Seinfeld’s advice to George Costanza’s bad luck
This seems to be the case for investor behavior too. As you can see from the chart in Figure 1, investor flows are down since the financial crisis but the market has been going up. The financial crisis really screwed with people’s brains.
In the last 20-years, we have experienced some pretty severe downturns and people are sick and tired of losing money. Retired people had to go back to work and people ready to retire had to work longer. I know people who were close to retirement that had to keep working and only now are they finally retiring.
The volatility during this timeframe has been off the chart and people just have a hard time handling it. Unfortunately, they are pulling funds out of the market at wrong time. Buy high and sell low is not the goal.
Housing Crisis Volatility
How to handle stock market volatility might be partially found in how people reacted during the housing crisis. And I’ll use myself as an example.
My home value went from $450,000 down to $200,000, which was about the price I purchased it back in 2001. Notice how I highlight “home” instead of investment property … that probably has something to do with my behavior. Did I consider selling or walking away from my home? Of course not … it never crossed my mind.
It probably helped that I didn’t purchase my home at the peak ($450,000) like my next-door neighbor. That had to be painful because even today (10 years later) our homes are only worth $350,000. I’m up $150,000 and my neighbor is down $100,000.
I believe your cost basis impacts some investors behavior. If you are playing with house money (no pun intended) because you bought at the right time then you might be willing to ride things out and not panic.
It was unsettling to see my house drop more than 50% but I knew it would do it’s job – be a home to my family. We still had a place to live, we liked the house, and we had a plan for the house so the volatility had little impact to us. Can we say the same for our stock portfolio?
10 Tips For Handling Volatility
So let’s lay out a few thoughts on how to deal with volatility. I wish I had these earlier in my life because it would have helped me during the scary times. If you add up all these tactics, you can see there is much you can do to manage yourself when volatile times occur. Until I documented all 10 Tips, I was actually surprised that you do have control when times seem crazy
Tip #1 – Own Strong Companies
During the oil downturn of 2015-2016, I owned some small, cheap, and heavily leveraged oil companies that went bankrupt. During the Tech crash of 2000-2002, I had some small and highly volatile tech companies that went to zero. Are you seeing a pattern (other than I’m an idiot)?
Owning strong large cap stocks like Exxon Mobil, Coca-Cola, or Pepsi gives you the confidence to not panic. That’s why I’ve changed my investing style to one that buys companies from my Master Stock List. These are “sleep well at night” stocks and I plan to hold them forever.
Don’t tell me it’s not sexy to own these mainly large dividend paying stocks. It’s a great feeling knowing I’ve got an automatic dividend buffer when the market is going down. These are strong companies that have been around for longer than I’ve been alive and some have been paying dividends since the 1800’s.
Tip #2 – Always Have Some Available Cash
Warren Buffet has said more than once that real wealth starts when you’ve got cash (and others don’t) and the market is spiraling down. Having some cash on hand sure helps me remain calm when the market is moving down hard. Buying low and having a long time horizon is the key to building long-term wealth with these large companies.
I love building a position in stocks. I’ll go back to this chart of Coca-Cola that shows all the opportunities (marked 1-13) I’ve had since 2003 to buy some shares – 100 shares, 50 share, 150 shares, and so on. Before you know it you’ve got 500-1,000 shares of an American icon that’s paying you a dividend every quarter.
Having cash on-hand and ready to buy during a downturn will help you maintain calm and focus. When there’s panic and “sky is falling” attitudes then those with cash will reap the rewards.
Tip #3 – Have A Plan and Purpose For Your Portfolio
I know exactly why I’m building my taxable stock portfolio. I know because I wrote my Stock Policy Statement to help guide me when I most needed it. And those times are now …. when the market is gyrating up and down on a regular basis.
Every time I buy a stock from my Master Stock List, I’m buying future passive income. This income will supplement my retirement. If I buy 100 shares of Exxon Mobil, I’m buying $348 of future (and growing) annual income with a company that has increased their dividend for over 35+ years.
Just have a plan that will be your North Star when times are tough and let it guide you when your emotions might be running high.
Tip #4 – Your Cost Basis Is Important
Just like the example of my house losing over 50% in value during the housing crisis, I felt better because I didn’t have a loss. I was at break even versus being down $250,000 like my neighbor who bought their house at the peak of the market.
Well, the same goes for your stock portfolio too. If I bought a stock at $50 and it goes up to $75 then I’m feeling pretty good being up 50%. But if the market gets volatile and my $75 stock drops 50% then it’s worth $37.50 now, which is below my $50 cost basis. Yes, it did drop 50% but because I had a $50 cost basis it helped convince me that I was only down 25%.
Staying calm is very much about your emotional behavior and a lower cost basis is powerful. to our mind. Help yourself by being patient and knowing the prices that make your stock purchases good values.
Tip #5 – Reinvest Your Dividends
If you have some time on your side, this is a fantastic way to take advantage of volatile markets and lower prices. Let’s use my 300 AT&T shares as an example. When I retire in six years, I’ll have approximately 100 more shares of stock because I’m reinvesting those dividends. Not only do I have another ~$3,500 dollars of market value but I will have added over $600 per year in income too.
If you have 20 years until retirement and you were to reinvest your AT&T dividends then you’ll have more than doubled your share count (from 300 to over 600) and your dividend income will go from over $600 per year to over $1,800 per year. All because you reinvested dividends.
Tip #6 – Don’t Get Caught Up in the Headlines
I’ve spoke about this before but the TV talking heads just create noise. It’s ok to understand some insights from some people you trust but don’t let them get you down.
Hearing negative things can make you negative. That can lead to irrational and emotional decisions. Don’t be too positive and don’t be too negative … just create your plan and execute your plan (and focus on these tips).
Tip #7 – Maintain Your Asset Allocation
If your plan is to maintain a 60% stock / 40% bond asset allocation, then making sure you are at or near those levels during volatile times is important. So many times during the last recessions, I heard people close to retirement with 80% of their portfolio in stocks when their plan was 50-60%.
I warned so many of my friends during the financial crisis … some I saved and some didn’t listen. The ones that didn’t listen ended up selling near the bottom of the market because they finally decided to protect their capital …. this was the wrong time to protect their capital (after a 50%+ market drop).
Tip #8 – Plan for Conservative Returns
For most of my positions, I’ve planned for very conservative returns. This lowers expectations and keeps me realizing that as long as I hit my targets then I’ll be in good retirement shape.
For my Taxable Stocks, I’m only planning for a 3.5% return and I’m confident that I’ll beat that so I have upside. If I were expecting 8-10% returns, then I might start panicking about my losses during volatile times. But at 3.5%, I’m cool as a cucumber (a far cry from my earlier life).
Tip #9 – If Retired, Reduce Your Expenses
If you are living off your dividends, reduce your expenses some so that you can put some of those funds back into the market. If you have a $20,000 travel budget then only spend $10,000 this year and reinvest the other $10,000. During the volatility, either add to a current position or start a new position for a stock that has been beaten down.
Tip #10 – Don’t Sell At the Bottom
Just don’t do it … don’t panic, be calm, and do some of the other steps. Enough said but it needed to be said. It’s not really a tip but more of a reminder.
Conclusion
None of these tips on their own will keep you from getting into “sky is falling” mode, but doing several or all of them together will work wonders. Just the process of me documenting this article has helped my psyche to stay calm during these volatile days.
It’s actually very comforting for my wife and I – we are no longer running scared when the market gets crushed. We aren’t excited when the market is getting crushed but this “sky is falling” mentality is exactly when we will buy more. Now we see opportunity versus being fearful. This simple change in behavior will help us build greater wealth.
Owning companies like Coca-Cola, Exxon Mobil, 3M and many more on my Master Stock List will get you through the tough times. These are the companies that will be left standing in even the worst market conditions. They are the best of the best and have withstood the test of time, crisis, and war.
Stay calm and thanks for reading!
Mr. TLR