Originally published on Kiplinger.com
A global recession seems to be looming over investors. According to a probability model run by The Conference Board (opens in new tab) in October 2022, there is a 96% likelihood of a recession in the U.S. within the next 12 months. Expectedly, investors are spooked, and rightly so: Interest rates have increased, down payments have disappeared, and retirement timelines have shifted. The markets are constantly changing and have proven to be unpredictable.
An unpredictable and unstable market can easily impact our emotional state and lead us to make rash decisions. These rash decisions are common. According to a study by MagnifyMoney (opens in new tab), 66% of investors have made an impulsive or emotionally charged investing decision they later regretted. Even experienced investors with firm goals, focused exclusively on long-term growth, can become impulsive and reactionary when faced with changing variables like market movements, low company earnings and corporate actions.
This is not to say that we should exclusively do nothing during market volatility. Once we acknowledge that the impulse to sell right away during a downturn is governed by our emotions, we can begin to view market downturns as an opportunity to reflect on our strengths and weaknesses as investors, evaluate changing opportunities and double down on our long-term goals.
In my experience, there are five important investing choices investors can make during volatile times. Which of the following actions an investor should take depends entirely on their current portfolio, economic goals and lifestyle.
1. Investors Can Adjust Their Portfolio Targets.
This is a good fit for investors who, when going through a downturn, realized that their portfolio choices were riskier than they actually have appetite for. They can adjust their investment options to be more conservative, shift assets into high-yielding savings and checking accounts and/or pay down debt.
Higher-risk portfolios tend to be equity heavy, while a conservative approach may favor bonds. One could use the Modern Portfolio Theory as a benchmark when assessing risk and building out their portfolio.
2. Investors Can Invest More and Buy the Dip.
This is for the investor who is secure in their financial stability and recognizes the great buying opportunity available for them. These investors tend to park their cash in brokerage accounts, automating their contributions.
On M1 (opens in new tab), this looks like using auto-invest or Smart Transfers on a schedule that works for them. We see a range of recurring transfers weekly, biweekly, monthly and beyond.
3. Investors Can Take Advantage of the Dip by Moving Positions.
The strategy of “moving positions” is similar to buying the dip, but takes it one step further — by moving positions to be in stocks that will benefit once the market bounces back up. For example, an expensive stock that an investor might not usually be able to afford will become cheaper during the dip, allowing them to buy into something they wouldn’t be able to under normal circumstances.
This move should solely be done by an investor who has researched objective factors, analyzed risk and carefully weighed the pros and cons. Consider macro factors that may affect the new position, prior performance during downturns and industry benchmark.
4. Investors Can Cautiously Sell.
In most cases, this is the right move for a very small subsector of investors — those who believe the big dip is still coming and want to hold everything as cash or cash alternatives until the danger subsides and plan on re-entering once the markets have stabilized.
Selling, of course, could minimize your taxes at the end of the year if you sell at a loss and decrease your end-of-year tax burden. This will also release you from a potential loss in capital if you believe the price will decrease in the future and could minimize your capital loss overall.
However, when you sell your security, you will lose your proportionate share of ownership and the rights to any potential dividends or capital gains in the future.
5. Lastly, and Maybe Most Important, Investors Can Do Nothing.
This is for the investor who is confident that, despite any temporary volatility, their portfolio will stay the course. Oftentimes, this is a fit for an experienced investor who has weathered previous downturns, coming out the other side still standing.
The choices that investors make during periods of volatility are highly personal. It’s impossible to say that one investment move can work for everyone. However, decades of economic research show that investors shouldn’t base their decision to buy, sell or adjust their portfolio based on emotional reasoning.
Often (and with hindsight’s benefit), small, thoughtful moves can pay dividends in the long run.