5 Ways To Prepare For Market Volatility
The Chicago Board Options Exchange’s Volatility Index (VIX), often referred to as the “Fear Index”, has risen to its highest peak since the earlier days of the COVID-19 Pandemic, confirming the prevalence of a sentiment that we all likely have been feeling. Investors are afraid.
The Russian invasion of Ukraine unfolded against a backdrop of COVID-19 outbreaks, ongoing business supply chain shortages, a sharply elevated rate of inflation, and the Federal Reserve’s signaled intentions of raising interest rates. The stunning events of the last month have only added new dimensions of uncertainty to an already murky outlook. How will the European Union cope with a disrupted oil supply? What will be the ripple effects of sanctions on Russia? Will the conflict escalate to a third world war?
In the midst of all this uncertainty, we wanted to share 5 simple strategies that we have been advising our clients to consider in preparation for the potential volatility ahead.
1) Ensure that money invested in the stock market is designated for long term purposes.
The stock market is a great way to grow your wealth but comes at the cost of wide swings in prices. It’s best to ensure that any money invested in stocks (through individual equities, mutual funds, or ETFs) does not need to be converted to cash for spending needs in the next 5 to 10 years. This would give ample time for markets to recover in the event of a significant crash and ensure that you are not forced to sell when prices are low.
A great measuring stick is to add up the accounts invested in equities and calculate the balance assuming the market declines 50%. Ask yourself whether this will cause real financial distress and if so, consider shifting your portfolio to bonds or cash to insulate from a further decline.
2) Check the quality of your investments.
Now would be the time to reconsider holding a high concentration in speculative investments and instead shift your portfolio toward strategies that are fundamentally sound. Portfolios that are made up of high quality, financially durable stocks are more likely to protect value when the market declines.
3) Be prepared to reallocate bonds or cash into equities if the stock market crashes.
While we can’t predict the extent of the current correction, we do know that the market will eventually recover. In the words of Warren Buffett, “Be fearful when others are greedy and be greedy when others are fearful”. As the market declines, we suggest that investors identify any cash or fixed income that can be stowed away for 5 to 10 years and consider investing it in equities while prices are depressed.
4) Also consider converting your traditional IRA balance to a Roth.
Because you pay taxes on the market value of the balance you convert, executing a conversion while the market has experienced a dip would mean paying less taxes. We discuss the long-term advantages of the Roth IRA in a separate post and recommend that you consider converting funds if you can afford the additional taxes.
As always, we invite you to reach out to us and/or your CPA to discuss this technique.
5) Stay patient.
Most importantly, stay patient during market downturns and resist the temptation to sell investments. Consistently predicting whether markets will continue trending downward or suddenly reverse course is virtually impossible (see our blog post on market timing here) and mistiming a sale can significantly reduce your long-term rate of return.
Instead, rest assured that an attractive return in the broad stock market is almost a certainty if the investment process is given enough time. Assuming you follow steps 1 and 2 above, your assets should be well positioned to weather the storm.
Navigating periods of market turbulence can be unnerving and without a proper plan, you might be at a higher risk of making a poor decision. While not exhaustive, we think this list of 5 strategies can assist you in avoiding the common pitfalls that put future financial success at jeopardy. If you would like to discuss or require assistance with executing any of these strategies, please do not hesitate to contact us at team@jsopartners.com or 215-283-3131.
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