Are you having fun yet?
With financial markets plunging over the past few weeks, many investors are understandably upset. Everything seemed to be going well and then – boom!
Well, I've got some bad news for you: There's another gut-wrenching correction coming. I don't know when – it could be next week, next year or some time after that – but I can guarantee you it will happen again. If you're going to invest in equities, there is simply no way to escape it.
Now for the good news: How you react to market turmoil will have a huge impact on your returns in the long run. You cannot control what markets do, but you can – with some practice – learn to control your emotions and behaviour when all heck breaks loose. And that will make an enormous difference, not only to your portfolio's performance, but to your stress levels.
That's where today's column comes in. While markets were plummeting this week, I contacted three Canadian portfolio managers – in Toronto, Winnipeg and Vancouver – to ask which strategies they use, both for themselves and for their clients, to cope with extreme volatility. I'll share some of their tips below, along with some of the things that have worked for me.
Remember that it's normal
When stocks are free-falling, many investors are so focused on the red numbers on their computer screens that they forget two critical things: severe selloffs are a perfectly normal feature of financial markets; and these selloffs are minor compared with the long-term upward trend of the market. If you look at a long-term chart of the S&P/TSX composite index a few years from now, the recent drop will be a blip.
"I tell clients to take a deep breath. The end of the world is not here. This has happened before. It's not new," says Adrian Mastracci, president of KCM Wealth Management in Vancouver. Remember, too, that being frightened is normal, but don't make the mistake of letting that fear rule your decisions.
Keep the drop in context
From its Sept. 3 high to its Oct. 15 low, the S&P/TSX composite index skidded 1,788 points or 11.4 per cent. But even at its low, the index was only back its levels of last February. If you'd bought a low-cost index fund 10 years ago and held it through the recent correction, you still would have doubled your money, including reinvested dividends. And remember, that period included a far deeper drop in 2008-2009.
Focus on the long term
As hackneyed as this phrase is, it's incredibly important. "You have to think long term. We still like owning blue-chip dividend-paying stocks that are good businesses, and that is the best approach for anybody who has a time horizon of five years or more." says Tony Demarin, president of BCV Asset Management in Winnipeg
If you aren't planning to sell your companies any time soon, there is no reason to get bent out of shape because the market is temporarily assigning them a lower value today. If profits are growing and the companies themselves are sound, ultimately this will be reflected in higher stock prices down the road.
"I have to take a giant step back and recognize that markets are volatile, but it doesn't reflect the true long-term value of the businesses that we own," Mr. Demarin says. "As Warren Buffett said, 'If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes.'"
Tweak your asset allocation
Some investors think they can withstand a correction, but then find out they don't have the stomach for it. "A lot of people don't really know themselves," says Greg Newman, associate portfolio manager with Newman Group at ScotiaMcLeod in Toronto. "One day they're fragile for whatever reason – they don't get a bonus, or they lose a job, or the kid they're paying for costs them more money."
When that happens, they might be tempted to sell – and the miss the eventual rebound. To prevent fear from taking over in a correction, it's important to prepare in advance by ensuring that the your asset allocation to stocks, fixed-income and other asset classes fits your risk tolerance.
By enrolling stocks in a dividend reinvestment plan (DRIP), investors take the emotion out of what to do with cash that accumulates in the portfolio. "What I have found is that people who can buy good quality stocks, keep the DRIPs and see it through tend to do really, really well over time," says Mr. Newman. Because DRIPs are automatic, they force investors to buy during a downturn when they might otherwise not have the courage to do so.
Turn the selloff into an opportunity
The three portfolio managers interviewed for this column have one thing in common: all were buying stocks even as the markets were plunging this week. That turned out to be a wise move, because markets rebounded on Thursday and Friday. I also bought more dividend stocks and ETFs – at prices substantially lower than they were just a few weeks ago.
Corrections are normal. They have happened before and will happen again. It's never too early to start preparing for the next one by reviewing your asset allocation, reminding yourself to think long term and keeping some cash on hand to spend when great companies go on sale.