Entering the fourth quarter of 2014, the stock market’s gyrations have eliminated most of the earlier positive returns. But fearful investors should remember time is on their side—as long as they can tune out the noise.
As we enter the fourth quarter of 2014, the stock market’s gyrations have eliminated most of the earlier positive returns.
Heading into this week, the Dow Jones Industrial Average turned slightly negative, with the S&P 500 and NASDAQ hovering with meager gains in the 2-3% range. Following the positive returns of 2013, these results aren’t bad—but given that they represent drops in the 10% range from their 2014 highs, and that the Russell 2000 is off nearly 10% for the year, they indicate that many stock market investors are grumpy and the increasing volatility of the market is once again making them fearful.
Certainly, world events have been distressing—concerns about containing the spread of the Ebola virus coupled with the military gains and disturbing use of violence by ISIS. The economic news is mixed: macro-economic data in the U.S. appears to be fairly positive, although the local level doesn’t always seem to mirror national trends.
One catalyst for the large drop in last week’s stock market was disappointing news regarding German exports and the declining growth rate of the Chinese economy. Of course, anyone who invests in the stock market should understand that returns will fluctuate. And for some, the severe market drop during the Great Recession six years ago is now a distant memory in light of the strong returns achieved since then.
In periods of volatile stock market returns, it’s important for investors to base their approach and response to saving on their time horizon and objectives. While most understand that in an intuitive sense, it’s not easy to translate the strategy into a sense of calm when the DJIA experiences 300+ point swings. Investors should focus on long-term objectives—college expenses, retirement, etc.—and not worry about shorter-term results. Accordingly, investment allocations should reflect their timeframes and risk tolerance. Investment discipline is necessary in avoiding “buying high and selling low.” One effective tactic: periodically “rebalance” the investment account by allocating stocks, bonds and other options to predetermined ratios, such as 60% stocks, 30% bonds and 10% real estate. Some investors approach this on an annual or semi-annual basis.
It’s also important to keep in mind that because the steepest drop in the stock market occurred later in the year, actual returns will most likely be lower if investors have been adding funds to their account. Investment return reports are based on a time-weighted return—meaning the return is based solely on elapsed time rather than when funds were invested during the year (known as a dollar-weighted return). As a result, the returns will vary for each investor based on the periodic cash flow of investments.
Periods of volatility in the stock market are inevitable. When anxiety sets in, investors should keep in mind that time is on their side—as long as they can tune out the noise.
Dave Evans is a certified financial planner and an IA contributor.
