Every week seems to bring a new “crisis,” which is why investors should have a plan to navigate all the uncertainty. Markets are volatile because human beings are emotional and constantly react to new and unexpected information. Some of the issues contributing to recent market volatility include: military conflicts that affect gas prices, growing defaults in the private debt markets, changes in employment thanks to artificial intelligence, uncertainty about future Federal Reserve leadership, and mid-term elections that are likely to change governmental tax and spending policies.
A savvy long-term investor recognizes these events are virtually impossible to predict, so they wisely don’t try. A better approach is to use market volatility to your advantage by focusing on a simple three-part strategy: steady investing, diversification and rebalancing. It might sound basic, but it works. And the best part is, your 401(k) plan is well-suited to help.
Steady, not emotional, investing
401(k) plans let you invest a percentage of every paycheck automatically. This means you invest a similar dollar amount on a regular schedule, whether the market is up or down. This is called dollar-cost averaging. When prices are low, that fixed amount buys more shares. When prices are high, it buys fewer. In time, this usually lowers your average cost per share and takes the emotion out of the decision of when to invest. Instead of asking, “is now a good time?” you simply keep investing on schedule.
Spread your market risk
Diversification means not putting all your eggs in one basket. Ideally, you build a portfolio that contains a mix of investments, or asset classes, that respond differently to any given economic situation. The three most common asset classes are: Stocks – shares of companies with values that appreciate when the economy expands, Bonds – loans to governments or companies that often perform better during economic slowdowns or recessions, and Real Assets – investments tied to things like energy, metals, or agriculture that perform well during periods of unqexpected inflation or geopolitical stress.
In general, stocks offer higher potential returns but with bigger swings, while bonds offer lower potential returns with much less volatility. Real assets add an important layer of diversification, but are the most volatile and should represent the smallest part of the portfolio.
Set it but don’t forget it
Your mix of stocks, bonds and real assets depends on your age, risk tolerance and retirement goals. Once you determine your optimal mix of assets, the market will constantly pull your portfolio away from those targets.
This is where rebalancing comes in. Rebalancing means trimming back what has grown too large and adding to what has fallen behind. A simple way to do this is to set a “guardrail” around each target. Once you set the guardrail, don’t forget it. For example, if your target is 60% stocks, 30% bonds and 10% real assets, consider rebalancing whenever any piece is more than 10 percentage points above or below its target.
When the conflict in the Middle East causes the allocation to real assets in this example portfolio to surge, the mix in this example might shift to 55% stocks, 25% bonds and 20% real assets. Real assets are now 10 percentage points above their 10% target. In that case, you would sell some real assets and use the proceeds to buy more stocks and bonds until you are back to your original mix.
This sounds simple, but it runs against human nature. Our instincts tell us to buy more of what is doing well and sell what is doing poorly. Rebalancing forces you to do the opposite: sell some of what has become expensive and buy more of what has become cheaper. It’s a strategy that is less about boosting returns and more about keeping your risk level steady over time.
Putting it all together in your 401(k)
A 401(k) plan is a powerful tool because it lets you combine all three parts of this strategy in one place: (1) automatic payroll deductions make dollar-cost averaging easy, (2) a menu of stock, bond, and real asset funds allows for diversification, and (3) most plans make it simple to shift money among funds when it is time to rebalance.
If you need help putting your strategy together, you’re not alone. A qualified investment adviser can help you maintain a constructive relationship between your portfolio and the market, one that fits your comfort with risk and your retirement timeline. Market volatility will never go away, but you don’t have to figure it out. By investing steadily, diversifying broadly and rebalancing with discipline, you can turn market volatility from something to fear into something you can take advantage of in the long run.
The information contained herein is provided for informational purposes only. The information provided is from sources we believe to be reliable, but we cannot guarantee its accuracy or completeness. Neither the information nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Francis LLC does not offer personal legal advice.
