How to Invest in Highly Volatile, Uncertain Markets
Considering the wild swings in worldwide stock markets over the last several months, I am focusing my comments this quarter on how to invest in highly volatile, uncertain markets. Below, I will list four keys to successfully navigating these turbulent times.
Key #1: Remain Diversified: When markets move with greater volatility, investors commonly flock to investments that have performed the best over the most recent period. By chasing the best performing asset class, investors add risk to the portfolio by placing too much emphasis on any one investment. Many times, these investments are added to the portfolio after the asset class has risen significantly. By so doing, the investor reduces exposure to the undervalued assets in the portfolio while adding to the overvalued assets…..therefore creating greater risk of loss. By remaining diversified when the future is unpredictable, an investor is likely to keep portfolio risk / volatility lower.
Key #2: Know your time horizon: As short-term movements in the market (both up and down) are bound to happen, an investor must be aware of his or her time horizon, particularly in turbulent times. If there is a significant cash need from the portfolio within the foreseeable future, actions must be taken to reduce the portfolio risk/volatility. However, if there is a much longer time horizon, the investor must focus on the long-term plan. Short-term movements in the market typically have very little effect on a portfolio’s return over longer periods (20-30 years). If you are a long-term investor, avoid making rash decisions that could significantly alter your long-term goals (Example: Stopping your contributions, timing the market, etc.).
Key #3: Focus on Defensive Sectors: During uncertain, volatile markets, defensive sectors can help stabilize the volatility in your portfolio because their earnings are quite consistent in any market environment. Both Health Care and Utility companies are commonly seen as defensive categories as poor economic data does little to affect their company earnings. Common defensive stocks are Johnson & Johnson, Proctor & Gamble, and as of recently, McDonald’s. I am constantly impressed by McDonald’s ability to offer a product to a consumer at a lower cost than if the consumer went out and bought the supplies themselves. Let’s face it, families enjoy eating out…and when times are tough, they opt for the least expensive option. Defensive Sectors pay higher than average dividends to their investors. As such, these investments provide added income into your portfolio (as will be discussed in Key #4).
Key #4: Increase Portfolio Income: Portfolio volatility can be greatly reduced by focusing on income-oriented investments. Look for companies who provide high dividend payouts. Even when stock prices fluctuate, you are able to collect consistent income for the portfolio. Increased exposure to fixed income (bonds), preferred stock, Real Estate Investments Trusts, and high dividend-paying stocks will give you the added income you need to provide more consistent returns.