Building Portfolios for Volatile Times
Many of our investing clients are concerned about volatility in the stock market, and they have good reason to be. Even as the indexes reach new highs, there are so many days where the S&P 500 index lurches up and down that investors get nervous – and turn to us for guidance. With the continuing question of whether the Fed should cut interest rates, and the always tumultuous runup to a presidential election, we don’t expect this volatility to go away any time soon.
The most important thing to keep in mind, if you are invested with a long-term time frame, is not to get spooked. If you have that type of time horizon, you should see a market that’s rising over the long haul and not get concerned about immediate volatility. If you get scared and leave the market during difficult times, it’s very likely that you’ll miss out on gains.
Some recent examples: We had a downturn right before Christmas in 2018; if you would have come out of the market at that point and not gotten back until the beginning of 2019, you would have missed a sizable return. The S&P 500 had its worst-ever Christmas Eve, dropping 2.7 percent - but then gained 3 percent on December 26th. Even in the devastating 2008 downturn, there was a pretty steep rebound in the market shortly after it reached the bottom. Anyone who would have sold after the crash would have missed out on that.
Beyond that long-term mind-set, there are other investment strategies that help during volatile times as well. Active management can make a lot more sense for people in a volatile environment. When the S&P 500 is offering solid, steady returns, passive investing is very useful. But when there is more volatility in the market - or even a downturn - active managers can really protect on the downside, limiting your losses.
Fixed-income investing is another area that can often provide a shield against volatility, providing a kind of insurance in a portfolio since they are less volatile than stocks. But given the current very low interest rate environment, many investors are finding that bonds do not offer the types of returns they seek. Instead, we have seen people gravitate toward more dividend-paying equities, where they can get both income and return.
For purposes of diversification, which can provide a cushion in times of volatility, some people look toward alternative asset classes. Private real estate can serve this purpose, as well as private equity, which seems to be a category that most investors readily understand, since it’s about owning businesses. Hedge funds, on the other hand, tend to be expensive for a level of performance that is not usually exceptional, so they're not really on our radar.
Even more so than asset classes, continuity is the key to riding out difficult times. We spend a lot of upfront time selecting and getting to know asset managers; if we pick a manager we trust at the beginning of the process, we feel comfortable in not making changes when the market starts to churn. Even good managers will underperform sometimes, but we have confidence that over the long haul they will provide solid returns.
When the choppy times inevitably arrive, that kind of confidence makes it easier for you to survive them. For more information on what you can do to safeguard your investments through volatile markets, talk to your Baird Financial Advisor.
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