On Thursday, June 23, voters in the United Kingdom voted in favor of leaving the European Union. The S&P 500 Index reacted by shedding 3.5%, erasing all of its gains for the year. That may leave some investors wondering, What now?
In the immediate future, the United Kingdom (UK) will remain a member of the European Union (EU), as the process for exiting the EU is expected to take at least two years. As British parliament prepares for the UK’s exit, negotiations between the UK and the EU are likely to be contentious at times, and may even encourage other nations to make similar moves. In the near-term, equity market volatility is likely to remain elevated for at least the next few weeks until some of the shock factor wanes. Longer term, we believe the decision will have limited impact globally outside the Eurozone. The important question is, What does all of this mean for your portfolio?
Expect volatility, focus on what you can control
The run up in U.S. markets immediately prior to the UK's referendum, and then the big sell off after the results were announced, highlight the fact that no one can predict the future with any degree of certainty, including the outcome of any investment decision. Additionally, we cannot independently control what markets will do. The good news is, there are some things investors can control, which we believe can help you be a more successful investor. Here are four suggestions that might help you navigate market volatility over the next year:
Maintain a long-term focus.
Asset allocation (the mixture of stocks and bonds in your portfolio) is the largest determinant of long-term investment performance. Selecting and then maintaining the proper asset allocation based on factors like your age, time horizon, investment goals, tax situation, and liquidity needs, is far more effective than picking the right stocks or trying to outguess the markets. Investing is long-term, so for money you’ll need to access within the next five years, we do not recommend investing in equities. You’re better off keeping those funds in cash or very liquid, short-term accounts. For money you don't anticipate needing within the next five years, you might consider equities. Historically stocks have outperformed bonds because stocks carry higher risk. Even older investors may need to include some stock investments in their portfolio. Retirees in their 60s and 70s, for example, need to remember their time horizon may be 15 or 20 years or more. That’s a long time and may require some equities to ensure they do not lose purchasing power due to long-term inflation rates.
Uncertainty carries risks, but it also creates opportunities. Rebalancing seeks to exploit price drops by selling assets that have appreciated and buying assets that have declined. (You’ve heard the mantra buy-low, sell-high. That’s what rebalancing seeks to achieve.) During periods of intense market volatility, it is important to monitor your portfolio and seek opportunities to rebalance and restore your portfolio back to its target allocation.
Have a written Plan.
Everyone seems to have higher risk tolerance when markets are doing well. But when things fall apart, people often realize their risk tolerance isn’t quite as high. That is why having a written Investment Policy Statement (IPS) is so important. In a written Investment Policy Statement, you decide in advance what your target asset allocation will be, and you define what the trigger points will be to rebalance. It can be a great way to ensure your emotions do not drive investment decisions.
In periods of market volatility, it can be difficult not to allow emotions to influence investment decisions. In January, for example, the S&P Index dropped over 10%, which technically constituted a “correction.” Many experts warned of imminent doom for the markets. Many investors felt it was time to get out of the market because “this time it’s different.” By the end of March, the S&P 500 had recovered, U.S. markets were back in positive territory for the year, and the “talking heads” moved on to the next big story. Attempting to outguess the market is a losing game, as research suggests very few can do it consistently. So avoid trying to time the market. Being out of the market at the wrong time can be costly.
Bottom Line: Patient investors who remain fully invested during market swings, and who stay committed to their long-term plan, are often the ones rewarded in the long-run.