How to Handle Stock Market Volatility

Warren Buffett is the world’s third richest man, worth over $80 billion, and he made it all from investing.  His advice on how to handle stock market volatility is worth listening to.

During times of volatility, Buffett says it’s best to stay calm and stick to the basics, meaning buy-and-hold for the long term.

In his 2017 Berkshire Hathaway shareholder letter, he quoted a classic poem by Rudyard Kipling titled “If”.  His advice to nervous investors enduring market downturns ….

If you can keep your head when all about you are losing theirs …
If you can wait and not be tired by waiting …
If you can think – and not make thoughts your aim …
If you can trust yourself when all men doubt you …
Yours is the Earth and everything that’s in it.

How Panic Hurts Your Long-term Stock Market Portfolio

There is a very human tendency to do something, anything, as you see previous gains reduced and positive returns turn negative.  That’s when people who panic make mistakes.

Market downturns are inevitable, Buffett pointed out, using his own company as an example:

Berkshire, itself, provides some vivid examples of how price randomness in the short term can obscure long-term growth in value. For the last 53 years, the company has built value by reinvesting its earnings and letting compound interest work its magic. Year by year, we have moved forward. Yet Berkshire shares have suffered four truly major dips.

He went on to cite each of the steep share-price drops, including the most recent one from September 2008 to March 2009, when Berkshire shares plummeted 50.7 percent.

Major declines have happened before and are going to happen again, he says: “No one can tell you when these will happen. The light can at any time go from green to red without pausing at yellow.

Rather than watch the market closely and panic, keep a level head. Market downturns “offer extraordinary opportunities to those who are not handicapped by debt,” he says, which brings up another important investing lesson: Never borrow money to buy stocks.

Key Strategies to Weather Stock Market Volatility

There are several reasons people panic and “lose their heads” when they see the value of their investments decline.   Here are three of the most common.

1. Have a 6-month Cash Cushion

They don’t have a cash cushion.  It is imperative that everyone needs to have a certain amount of safe money that can be used to pay the bills for at least 6 months without touching their investment portfolio.

2. Diversification Helps Protect Your Portfolio

Fear of “losing it all.”   This is usually an irrational response to a temporary decline in the stock market.  Markets don’t go to zero. The only way anyone can lose their entire investment is if they own a single stock and the company goes bankrupt.  

This is, of course, the reason that professional investors create properly diversified portfolios that are not concentrated in the stock of a single company or a single industry.

3. Talk with a Full-time Stock Market Professional

Have you ever heard of anchoring bias? It’s a common human tendency to rely on one piece of information or data when making decisions.  Many amateur investors fixate on the maximum value their portfolios reach and view any decline from that a “loss.” This even affects people who do not depend on their investments for income or their personal needs.  

Just like you wouldn’t fly a plane yourself when you want to travel somewhere, you want to work with someone who has spent years in their profession and is confident at the controls. Rather than panic or focus in on a small amount of information, an experienced advisor will help you navigate the ups and downs of investing with their wealth of experience.

Problems Overreacting Investors Face

Investors tend to see short-term volatility as the enemy.  It can lead many investors to move money out of the market and “sit on the sidelines” until things “calm down.”  Even if this approach appears to solve one problem, it creates several others.

  1. When to get back in?  For this to work, you must be able to make two back-to-back correct decisions: when to get out and when to get in.
  2. By going to the sidelines (cash or Treasuries) you may be missing the next rebound.  The next market recovery almost always begins at the point of greatest pessimism and fear. If you were scared out of the market when it began to decline you will surely be too afraid to get back in when it is at its lowest point.
  3. By going to the sidelines you could not only be missing the next rebound but all the potential growth on that money going forward.  Some investors who went to cash during the Great Recession of 2008 are still wondering if this is the time to get back in.

In 2009, during the last great market panic, the S&P 500 stock index declined 28% early in the year but rebounded enough to return 23% for the full year.

Like Warren Buffett, we believe that the wise course of action is to have a plan and follow it during both good and bad times.  This reduces the chances that emotion takes over and the desire to “do something” that leads to mistakes.

If you don’t have a plan, recognizing that your emotions can lead you astray, finding an experienced financial advisor, a fiduciary who can create a plan and a properly diversified portfolio can be a big step toward taking Warren Buffett’s advice.

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