There are only a couple of absolute guarantees that I can always make when it comes to investing in the stock market. The stock market will rise and the stock market will fall. One of those two things will happen at the end of every day. The emotions that these two movements in the markets tends to cause a level of crazy that most people can’t handle.
Since the 2008 Great Recession, the market has been nice a quiet, moving upward at a blistering pace, resulting in one of the longest growth periods (or bull markets) in history. Many millennials and new investors know nothing other than stocks going up, resulting in nice gains.
Of course, the market does not always continue straight up, and people need to be prepared for an eventual volatility increase that can lead to uncertainty in the market. The stock market does not like uncertainty, usually resulting in a downturn for stocks. Taking some time to understand volatility and having a plan to handle this is prudent.
The VIX Indicator
The Volatility Index (VIX) was created as a forward-looking indicator of future volatility in the market. It is often called the fear gauge. A rule of thumb is that when the VIX rises above 30, there is a lot of fear and uncertainty in the market. Values under 20 represent less stressful or even complacent attitudes in the market.
Here is a chart of the VIX over the last 10 years. You can see in this chart the VIX was around 80 during the height of the great recession. It has spiked above 40 a few times in the aftermath of this event. Since 2012, the VIX has not spent time above 30.
This is to show that according to the VIX, the market is calm, and has extremely low volatility. It has actually been at time the lowest VIX ever. A lot of experts are predicting this run can’t last forever, and people need to be ready for an inevitable rise in the fear gauge.
This means a lot of investors may not understand what can happen when the market has real uncertainty. There are a variety of world events, economic events, or potential disasters that can cause the VIX index to rise dramatically. I am not here predicting a date as to when this could happen. I do know that it will eventually happen, and it is wise to prepare now.
Here are three important steps to take when there is volatility in the market, and stocks fluctuate wildly and people start to panic. Even if the volatility doesn’t come for years, bookmark this page and come back to it when you start to feel nervous being invested.
Review Your Investments
The first step is definitely NOT panic and sell. That has been shown to be a major detriment for main street investors. Take time to sit down and evaluate your investments when you start to feel a bit scared in the market. Make sure you understand why you bought your investment, what purpose they serve in your portfolio, and do they still fit the bill.
While you may see that some investments may fare worse in a downturn or volatility event than others, try to look 5 or 10 years down the road. Is the company strong enough to withstand a few years of bad business? You may get a lot of gloom and doom news when the market becomes volatile. It is important to think objectively and cut out this negative noise.
If you have bought a well-diversified portfolio of quality investments, hopefully this exercise proves that you have done a great job, and you can continue on to other things instead of worrying about your investments. This first step should allow you to take a deep breath, and calm your nerves in case of a market correction.
Stick to Your Plan
Understand what your goal for investing is. Are you planning to be invested in the market for 20 or 30 years? Look at where you are in this goal and timeframe, and then stick to that plan. A bump along the way tends to right itself over the long-term. If people held through 2008 instead of selling, many would have made back their losses and been able to participate in this massive stock run up.
Having a plan and sticking to it through the ups and downs is the most important part. The only price that matters is when you are buying or selling. All of the other days are just different prices for other people. As best as you can, take the emotion off of the table, knowing that your executed plan will work.
Continue Buying Investments
If you’re sticking to your plan and not panic selling, then shut out the noise and continue buying investments. Continue contributions to your 401(k) as usual, and also invest in your IRA or taxable accounts as well. If you understand your investments fit your goal, and your plan is in place, then these investments should still be bought.
If you purchase in regular intervals, this will allow you to have a lower cost per share of your investments. Dollar cost averaging in downturns can lead to much greater returns when the market rises again.
Read Also: My 3 Favorite Index ETFs
Timing the market is a bad idea for nearly all investors. It has been proven time and time again (see here) that it is all about time IN the market, not timing the market. Get invested, stay invested, and continue adding to your nest egg.
Being able to withstand the allure of selling and joining the herd can be difficult. It is difficult to be continuously buying when the talking heads on TV are spelling doom. Have a plan to avoid making the mistake of selling when it is not needed. These steps should give you confidence in your portfolio.
I have always figured that even the worst recessions have not wrecked the very strong American economy. While there have been close calls, our economy is a safe haven, resilient, and historically successful. These may not forever be the case, but sticking through volatile times in the market is important. It is also very important for young investors.
What do you do to prepare for a market downturn? How did you withstand the previous volatile stock market? Thank you as always for reading!