Smart Investing Steps You Can Take During the Current Bout of Volatility

It’s been a roller-coaster ride for the stock market so far this year. I’m not just talking about the daily changes but also what’s been happening on an intraday basis.

The chart to the right plots the percentage difference between the intraday high and the intraday low for the S&P 500 index, the Nasdaq composite and the Russell 2000 index. Larger numbers reflect higher levels of intraday volatility. As you can see, there have clearly been some very large swings between the daily highs and lows.

Volatility refers to the fluctuation in returns. Though often associated with downward moves, volatility is different than direction. Big swings to the upside can also occur during a volatile market environment. Unfortunately, so far this year, Mr. Market’s mood has been more anxious than content. Through Wednesday’s close, the S&P 500 had a year-to-date loss of 8.7%, the Nasdaq was down 13.4% and the Russell 2000 was down 12.0%. D’oh!

I’m going to share a few steps you can take to improve your long-term odds of investing success. Before I do, I want to share a few other observations about the current market environment:

• Yesterday’s close was notable because it put the S&P 500 on track to incur its worst January performance since 1950, according to the Stock Trader’s Almanac. (The index ended January 2009 down 8.6%). While negative January returns for the S&P 500 have historically been followed by below-average calendar-year returns, a drop in January does not necessarily mean full-year returns will be negative.
   
• Early-in-the-year drops are particularly common following calendar years with big gains. Sam Stovall of CFRA Research counted 17 years since World War II when the S&P 500 fell during the year following a year with gains of at least 20%. When these sell-offs start in the first quarter, the average drop is 10.9%.
   
• Fourth-quarter earnings have topped expectations by smaller margins compared to the previous four quarters. Reported earnings so far (145 S&P 500 companies as of Thursday morning) are running 3.2% above expectations. This is below the 16.0% average beat for the prior four quarters, according to Refinitiv.
   
• While the S&P 500 is frequently used as a market barometer, it is not the market. In a note issued on Tuesday, Charles Schwab’s Liz Ann Sonders observed that nearly half of the S&P 500’s members have already had at least a 10% drawdown this calendar year, while 65% of Nasdaq members and 70% of Russell 2000 stocks have fallen by at least 10% so far in 2022.
   
• The Federal Reserve is transitioning from an accommodative to a tightening stance. Included in yesterday’s Federal Open Market Committee meeting statement was a statement saying that “it will soon be appropriate to raise the target range for the federal funds rate.” This shift in policy is a contributor to the resetting of valuations we’re currently seeing occur in the financial markets.

What Can Investors Do Now?

Given all this, what can you do now to increase your odds of investing success? Here are suggestions.

• Be clear about your investing goals. If you’re an investor, there is something you hope to do with the money you’re investing. It could be funding retirement, buying a house, leaving an inheritance or amassing a large amount of wealth. Whatever your goals are, there are estimated target dollar amounts, expected times for when they will be reached and durations over which you will spend on the goals. These things should govern your investment decisions—not what the market is doing on a short-term basis. Our PRISM-Wealth Building Process is based on this concept.
   

• Stay the course. If you’ve set up your portfolio to reach your long-term goals, then continue to stick to your strategy. The risk of making a mistake by acting on what you think might happen is greater than the risk of what will actually happen.
   

• Don’t sell a stock if the company’s longer-term fundamental outlook has not changed. If there is a reasonable expectation that nothing about the company has changed other than temporary issues, then don’t sell. The exceptions to this statement would be the specific and prior use of price in your strategy, meaning technical analysis and predefined stops.
   

• Consider doing a Roth IRA conversion while stock prices are down. The IRS only cares about the dollar amount converted from a traditional IRA, a 401(k) or similar type of tax-deferred account to a Roth IRA, not the number of shares converted. So when prices are down, you can move more shares over to a Roth for the same tax impact.
   

• Accelerate the timing of IRA contributions. While I’m a big proponent of dollar-cost averaging, downturns are an opportune time to be a bit tactical. Downturns give you the opportunity to buy more shares for the same dollar amounts you would have contributed anyway. By accelerating, you’re simply shifting the timing of those contributions to take advantage of the cheaper prices.
   

• Go bargain hunting. The same logic applies here. A lack of optimism among other investors creates an opportunity for you to open your wallet. If the business is sound and you don’t have any reason to believe that its longer-term prospects have changed, you may be able to pick up some bargains.
  
  An alternative suggested by Lauren Templeton of Lauren Templeton Capital Management is to place limit orders to buy stocks at significant discounts to their intrinsic value (based on discounted cash flow or valuation multiples). If the price falls to your target, the order is executed. As a safeguard, she advises looking for companies with little to no debt. She said her great uncle, Sir John Templeton, used this strategy throughout his career.
   

• Turn off the TV, stop visiting financial news websites and just breathe. If your investment horizon is not one week, one month or one year, then there is no advantage to watching the market on a minute-by-minute or day-by-day basis. Paying constant attention to the market can cause you to become more nervous. As long as your cash flow needs are covered—salary if working; pension, Social Security benefits, portfolio income and/or two to four years of cash savings if retired—there is no need to react to the market’s short-term moves. Rather, find something more calming to engage in. Even spending a few minutes simply focused on your breathing can help.