There’s nothing like some furious stock market swings to tease average investors with thoughts of “How do I make money on this?”
It sounds tempting, but most professional investors will warn you not to try this at home. Following are a couple of basics to consider about the current volatility and whether you should dive in.
1. People are calling the recent stock market volatility a correction. What is a correction?
A correction is generally considered a decline of 10 percent or more from the highest price of a group of stocks such as the Dow Jones industrial average or even an individual stock such as Apple. A decline of 20 percent or more from a high is considered a bear market.
Corrections signal that the equity, or stock, was overvalued. So the market is “correcting” the price to reflect a more accurate value, also referred to as fair value. However, a correction doesn’t necessarily bring a stock’s or bond’s price to fair value. Value is in the eye of the beholder.
2. Should I worry about a correction?
It doesn’t do any good to worry. Corrections happen. Stocks don’t go in only one direction. They move up and down. Market analysts consider those movements healthy because they put a realistic — or at least a cheaper — price on stocks. Think of how, when a store has too much of something in its inventory, it cuts the price until buyers come back. Same with stocks. They get ahead of themselves, so they need to come back to earth.
3. What should I do when a correction occurs?
Probably nothing. If you sell in a correction, you are selling shares as they are going down. If you are invested in the stock market, you should have a strong stomach that can tolerate its inevitable swings. If you are losing sleep over a downturn in stocks, you probably should not own stocks.
Rex Simmons, a 66-year-old retiree in Fairfax Station, Va., views the current tumult this way: “I’ve been through this before several times. We’ve had many corrections, and I’ve been through some steep downturns. The lesson learned from the past is stay the course. The objectives are long term.”
“If you have a balanced and diversified portfolio, you can ride these things out,” Simmons said. “The other thing is that a correction is an opportunity to rebalance your investments and maintain diversification. If you have 40 percent of your portfolio in stocks and it drops to 38 percent because of a correction, you buy more stocks at a cheaper price.”
4. Can’t you sell your profits and get back in after stocks go down?
Yes, but that is very difficult to do. Most investment advisers say the best thing is to ride out the plunges, just as Simmons is doing.
Billionaire Warren Buffett, widely hailed as one of the greatest, if not the greatest, investor of all time, thinks market timing is a terrible idea.
“People that think they can predict the short-term movement of the stock market — or listen to other people who talk about [timing the market] — they are making a big mistake,” Buffett said in a USA Today interview a few years ago.
John Payne, a 52-year-old consultant from Bethesda, Md., doesn’t follow Buffett’s advice.
When the turbulence began last week, Payne sold a big chunk of his holdings in highflying biotech and technology shares. He now has 30 percent of his portfolio in cash and is waiting for the market to calm down.
“The general conviction is you can’t time the market,” Payne said. “I understand the theory. But if I’m up 27 percent last year and up 12 percent in January, and I would like to get 8 percent returns long term, then I am taking some chips off the table.”
So he sold a bunch of stock and took his chips off the table.
Payne sees the political gridlock, the potential for inflation, the recent Republican tax cut and President Trump’s unpredictable behavior creating uncertainty that will continue to roil markets.
“I expect to work another 15 years,” he said. “I’ve been through the crash of ’99. I’ve been through 2009. When you start to see those 500-, 600-point days, it’s time to sell.”
Payne said the volatility also forced him to part with some of his beloved holdings.
“When you sell, you have to look it in the eye and say, ‘Do you love me?’” he said. “The great thing about downturns is it forces you to look at things you really don’t love.”
For now, he said, he is sitting on the sidelines, waiting for the market fury to abate.
5. How can I make money on this?
The best path for making money in a turbulent market is by saving and investing on a regular basis — also known as dollar-cost averaging. That means buying a fixed dollar amount of an investment on a regular schedule, no matter what the markets are doing.
Sure, you will pay more when shares are highly priced, but when the stock market drops more than 1,800 points, as it did Friday and Monday, you can grab some real deals by just adhering to the schedule. This becomes especially lucrative when a stock that pays a $1 dividend annually drops in price. If the stock drops from $50 to $25 because of a downturn, it still pays that $1 dividend. But you bought the shares at half-price.
6. How can I avoid losing money on this?
First, don’t sell your stocks when they are down. Investors are the one class of consumer that seems to want to buy when prices are high and sell when prices are low, which is counterintuitive if you think about it. You wouldn’t do that with a washing machine, a car or a stereo.
Plus, historically, stocks go up twice as frequently as they go down. They fluctuate, sometimes with big swings, but the vast majority of investors will tell you that over years and years, stocks are the best way to increase your wealth. Stay in low-cost index funds, and hold on for the long term.
7. If I move my money out of stocks, where else might I invest it? (Real estate? Park in CDs? Buy gold? Bonds?)
You can buy real estate, but real estate crashes just like stock markets, and it’s not a liquid asset. You can park your money in certificates of deposit, but you will be lucky if your interest rate keeps up with inflation. Gold doesn’t pay dividends. It is seen as a safe place to put your money to store value, but consider that, on an inflation-adjusted basis, gold hit an all-time high of $2,800 per ounce in 1980. Today it’s selling for less than half that.
Bonds are a good tool for diversification because they are generally not correlated with the stock market. When stocks are down, bonds may appreciate, and vice versa. But with interest rates low, they can’t be considered good growth candidates.
8. I’m retirement age and trying to protect against losses. What should I do in a market swoon?
First, don’t sell during the swoon. If a swoon is underway, you might want to sit tight until markets come back. Most investment advisers draw from a similar playbook that says the best protection against losses is a widely diversified portfolio of small and large U.S. stocks, some value stocks, international stocks, bonds, and shares in real estate investment trusts.