The increased stock market volatility experienced to date in 2016 has been driven by a global economic slowdown, leading to increased fears of a recession in the United States. The first quarter of 2016 marked only the second stock market correction the nation has experienced since 2011. A correction is defined as a decline of 10% or more. It is important to keep in mind that corrections are normal, healthy and historically have occurred on average about twice a year.
At this point, the U.S. economy does not appear likely to be on a path toward a recession in 2016. The economy is still growing, although at a slower pace of 2–2.5%. Consumer spending, 70% of the economy, is healthier and grew about 3% over the past 12 months. Inflation is well-contained, and recent employment trends also have been encouraging.
It is reasonable to expect market volatility to continue over the next few months as the markets react to periodic bouts of uncertainty and surprises — particularly in a very uncertain election year.
Contrary to the turbulence, some risk seekers may wonder if this is a good time to jump into the market and invest extra cash while the market is down. On a day-to-day basis, or over a very short-term time horizon of less than a year, the correct answer is that “no one knows for sure” because the stock market is largely driven in the short-term by sentiment and emotions.
It may be best to not do much trading when markets get extremely volatile. There is a classic investment saying about avoiding “catching a falling knife.” Volatile markets present a good opportunity to look at a number of additional ideas and also review and stress-test existing positions and assumptions.
It is important to understand what you own and why. If you have extra cash to invest toward long-term goals, anytime is generally a good time to add to your portfolio and invest accordingly where you can find the best risk-adjusted returns given your preferred level of risk.
Weather the Storm
If you were hoping to make a market-timing purchase to speculate, bank a quick return and use your anticipated profits to meet short-term goals or even intermediate goals over the next couple of years, you may want to avoid speculating because that is contrary to the principle that investors should not take more risk than needed to meet goals.
Here are five steps that investors can take to weather stock market turbulence.
- Distinguish financial resources required to meet short-term goals from long-term goals.
- Understand your cash-flow requirements. Cash needed to meet short-term goals should not be invested in the stock market because it may take several years to recover.
- Understand how volatile your investment portfolio has behaved in percentage terms relative to the risk of the overall stock market.
- Modify your investment plan by reducing your exposure to stocks if your needs have changed, or if you are uncomfortable with the current volatility of your portfolio.
- Stick to your long-term investment plan if you have sufficient financial resources to meet immediate needs and you can accept a higher degree of risk with funds targeted toward long-term goals that are greater than five years.
Christopher Parr, CFP, is president of Parr Financial Solutions, of Columbia. He can be reached at 410-740-9011 and via www.ParrFinancialSolutions.com.