Markets are off to a volatile start this year. Stocks and bonds fell sharply in January, and just when it looked like it was over, the sell-off continued.
Is the worst behind us or is there more volatility ahead? What does this mean for the rest of 2022?
Markets are famously unpredictable, and future markets are often different than most people (even experts) expect, but market history can help put current conditions in perspective and better understand what’s normal for the market.
This chart of the S&P 500’s calendar-year returns and intra-year declines since 1980 is one of our favorites. It’s easy to see that market declines are common and happened every year, even during bull markets.
While 2021 is still fresh in most investors’ minds, 2021 was an outlier: it was one of only four years when the S&P 500 saw drawdowns of 5% or less (1993, 1995, 2017, and 2021), so this year is likely to be different.
Stocks have frequently had steeper declines, but few pullbacks turn into bear markets. Schwab found that since 1974, only five market corrections (a drop of 10%) have become bear markets (a loss of 20% or more).
Why own stocks if there could be more volatility this year? Because stocks have finished most years with gains. The S&P 500 was up in 35 of the last 42 years, which is why it makes sense for long-term investors to stay invested.
Keep in mind that we’ve focused on the S&P 500 here, but other indexes like the Nasdaq 100 and the small-cap Russell 2000 have been more volatile over time, so if you’re invested in funds that track these indexes, you should expect more ups and downs along the way.
Since 1980, the S&P 500 had just one year when it dropped more than 40%; the tech-heavy Nasdaq 100 has had four drops of at least 40% in the last 20 years. The Russell 2000 fell -20% from its November 2021 peak to the January 2022 lows, marking its fifth bear market since 2009.
What to do (and what NOT to do) in volatile markets
Most investors know that down markets aren’t a good time to sell: they’ll lock in losses and history shows that by the time most investors get back in the market, they’ve missed out on gains. But it can be hard to do nothing; especially as volatility conditions continue, investors may feel greater pressure to take action.
So get a game plan together that can help you stay on track and use market declines to your advantage.
1. Plan for up and down markets
Since the Covid crash in March 2020, stocks have been on a tear, and it was relatively easy to make money. But this year may be a more challenging environment, as we’ve learned recently. So if you don’t have a clear investment plan in place, this is the time to create one.
In uncertain times, your plan is a reminder of what you know: why you’re investing and what you need to do to reach your goals. Most investors need to own stocks to build wealth, and they also need to mitigate risk so they can stay on course through volatile periods in the markets.
With our wealth management clients, we work to identify a risk level that works for their goals and needs, and from there, we tailor their allocation to stock, bond and/or alternative investments to align with their risk level.
Bonds and alternatives won’t necessarily prevent losses (no investment can promise that), but they can help limit losses, which can be enough to keep investors from panic-selling at the worst times.
Cash can also help you manage stock market downturns: if you have enough cash on hand to cover your expenses, you won’t be forced to sell stocks in a downturn.
2. The upside of down markets
Even in market declines, there are often investment opportunities. FundX investment advisors have used recent volatility to get some of their wealth management clients more fully invested at their target allocation.
If you’ve had money sitting in cash or in more conservative investments because you didn’t want to buy stocks at market peaks, then this could be a chance to add to stocks at lower levels.
FundX advisors also use down markets to harvest losses in taxable accounts, which can be used to offset taxes on gains.
3. Don’t let uncertainty hold you back
When there’s so much uncertainty, you may feel like pressing pause on your investment plans until things settle down or you have more information. It’s logical to expect that with more time, you will have a better sense of what to do with your investments, but the reality is that more information doesn’t necessarily make it easier to invest.
We have a lot more information today about the Federal Reserve’s plans. We know more about inflation and Covid, and yet we still don’t know how all of this will ultimately play out in the markets.
So rather than holding out in the hopes that you’ll feel more certain later, focus on what you need to do to reach your financial goals. For most investors, that usually means coming up with a plan and sticking with it.
If you feel stuck, let’s talk. FundX investment advisors specialize in helping people adapt to change in the markets and in their lives–it’s what we’ve been doing for more than 50 years.