Three Things to Focus on When Markets are Volatile
Last Friday the US stock market as measured by the S&P 500 closed at $2,304.92 down 32% from its high exactly 30 days earlier. The last 30 days have been marked by extreme volatility stemming from uncertainty about COVID 19 and the government's response. As with all market crashes, it is impossible to know whether or not we have hit rock bottom. Watching the wild swings is exhilarating for some, terrifying for others. However, investors need not be powerless victims to the vicissitudes of the market. By focusing on their costs, asset allocation, and savings rate investors can proactively control those elements of investing that remain within their circle of influence, and reduce the stress caused by market volatility.
"In investing, you get what you don't pay for." That classic quote by the late John Bogle, the late founder of Vanguard and greatest advocate of low cost investing, underscores the mathematical fact that any money an investor pays in fees, loads, and commissions is money no longer in her portfolio earning her interest, dividends, and capital appreciation. Studies by mutual fund research company Morningstar have consistently proven that low fees are one of the best predictors of a mutual fund's success. If you have money in a high fee mutual fund in a taxable account a market drop is the perfect time to move that money to a lower cost fund while paying lower capital gains or even claiming a loss.
From October 10th, 2007 to March 9th, 2009 Vanguard's Total US Stock Market Index Fund (VTSAX) lost 55.29% of it's value. Over the same period Vanguard's Total US Bond Market Index Fund (VBTLX) was up 7.38% and a 50/50 mix of those investments would have lost only 23.95%. It is critical that investors be realistic about their tolerance for loss and add bonds to their stocks to hedge against market crashes. Assume any portion of your portfolio that is invested in stocks will lose up to 60% of its value in a market crash, and be brutally honest with yourself about how you will handle those kind of losses. If you have $500k in your IRA today are you OK with having only $200K this time next year? If not you need to increase the allocation to bonds until the potential losses become acceptable. A market crash is a good time to take a second look at your allocation and make sure it still makes sense. Since stocks have fallen you may want to sell bonds and buy more stocks in order to bring your allocation back into your goal range. It would be best not to sell stocks during the downturn, but if you determine your allocation to equity's is causing you undue stress you should definitely make a note to lower your allocation to stocks as soon as the market recovers.
Ultimately the greatest way to build wealth and control one's financial destiny is by focusing on one's savings rate. The markets are always uncertain and there is no way to precisely forecast their returns, but investors who save aggressively give themselves the best chance. The magic of saving is twofold: obviously the more one saves the faster one's nest egg grows, but the somewhat more elusive affect of savings rate is that any money you save is necessarily money you do not spend. By learning to live on less you reduce the amount of money needed to reach financial independence. The table below demonstrates the power of savings rate on the number of years required to reach financial independence (FI). It assumes a 5% real rate of return, 3% safe withdrawal rate, and $0 starting balance.
Market crashes can be scary. With no idea how far down the bottom is or when it will end, investors may find themselves swept up in the stress and fear of the unknown. However by focusing on those things that are firmly within their control: costs, asset allocation, and savings rate. Investors can sleep soundly at night knowing that they are responsibly managing their investments, and giving themselves the best possible chance of success.
"In investing, you get what you don't pay for." That classic quote by the late John Bogle, the late founder of Vanguard and greatest advocate of low cost investing, underscores the mathematical fact that any money an investor pays in fees, loads, and commissions is money no longer in her portfolio earning her interest, dividends, and capital appreciation. Studies by mutual fund research company Morningstar have consistently proven that low fees are one of the best predictors of a mutual fund's success. If you have money in a high fee mutual fund in a taxable account a market drop is the perfect time to move that money to a lower cost fund while paying lower capital gains or even claiming a loss.
From October 10th, 2007 to March 9th, 2009 Vanguard's Total US Stock Market Index Fund (VTSAX) lost 55.29% of it's value. Over the same period Vanguard's Total US Bond Market Index Fund (VBTLX) was up 7.38% and a 50/50 mix of those investments would have lost only 23.95%. It is critical that investors be realistic about their tolerance for loss and add bonds to their stocks to hedge against market crashes. Assume any portion of your portfolio that is invested in stocks will lose up to 60% of its value in a market crash, and be brutally honest with yourself about how you will handle those kind of losses. If you have $500k in your IRA today are you OK with having only $200K this time next year? If not you need to increase the allocation to bonds until the potential losses become acceptable. A market crash is a good time to take a second look at your allocation and make sure it still makes sense. Since stocks have fallen you may want to sell bonds and buy more stocks in order to bring your allocation back into your goal range. It would be best not to sell stocks during the downturn, but if you determine your allocation to equity's is causing you undue stress you should definitely make a note to lower your allocation to stocks as soon as the market recovers.
Ultimately the greatest way to build wealth and control one's financial destiny is by focusing on one's savings rate. The markets are always uncertain and there is no way to precisely forecast their returns, but investors who save aggressively give themselves the best chance. The magic of saving is twofold: obviously the more one saves the faster one's nest egg grows, but the somewhat more elusive affect of savings rate is that any money you save is necessarily money you do not spend. By learning to live on less you reduce the amount of money needed to reach financial independence. The table below demonstrates the power of savings rate on the number of years required to reach financial independence (FI). It assumes a 5% real rate of return, 3% safe withdrawal rate, and $0 starting balance.
Market crashes can be scary. With no idea how far down the bottom is or when it will end, investors may find themselves swept up in the stress and fear of the unknown. However by focusing on those things that are firmly within their control: costs, asset allocation, and savings rate. Investors can sleep soundly at night knowing that they are responsibly managing their investments, and giving themselves the best possible chance of success.
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