Investing in volatile markets: Common-sense strategies

June 1, 2000
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Most investors at some time experience some anxiety about volatility in the stock and bond markets.

How should you proceed during these volatile times?

Long-term perspective

A long-term investment perspective is the key to weathering periods of market volatility. Long-term investors understand that time tends to smooth out the short-term fluctuations of the financial markets.

Taking the long view places sudden declines and gains in their proper perspective. Investment risk may even be viewed differently from a long-term perspective.

For example, many investors believe that stocks carry higher levels of risk than most other investments. But over the long term, stocks have consistently provided positive returns.

Since 1925, the stock market has grown at an average of more than 10% a year, compounded annually. That’s a remarkable record when you consider that over the course of those 70 years, we’ve experienced two stock market crashes, four wars, countless recessions, and 12 different presidential administrations (source: Ibbotson Associates).

Maintaining a long-term perspective does not mean constructing your portfolio and leaving it alone.

What it does mean is re-evaluating your goals and investment strategies when conditions are changing.

Strategies for volatile markets

1. Adopt a more defensive asset-allocation plan.

Asset allocation is the process of diversifying your funds among various types of stocks, bonds, and cash equivalent (maturities of less than one year), investments in proportions that work for your particular circumstances.

In this environment, using select fixed-income securities, we would continue the process of creating balance in portfolios that have become overweighted in more risk-oriented equity investments.

A strategic mix of types of investments can help in reducing overall portfolio volatility; however, it is not a one-time decision. It is a process that should be done periodically in response to your changing needs and changing market conditions.

2. Reposition into new market leaders.

One of the primary risks during market volatility, is that investors continue to hold yesterday’s market leaders instead of tomorrow’s. The first step in repositioning your portfolio would be to eliminate those holdings that are not expected to participate in the gains of the next phase of the market cycle.

How do you identify which stocks are which? Investment strategists use fundamental and technical analyses.

Fundamental analysis attempts to forecast securities prices through a complete analysis of the underlying company, including its assets, earnings, management, products, sales, and target markets.

Technical analysis uses historical price and trading volume data to forecast future price movements. Speak with your financial consultant about conducting a thorough review of your stock portfolio with an eye toward these important issues.

More speculative, lower-quality issues should be reconsidered, especially if their market liquidity is not very good. Be careful with companies having relatively high fixed costs that cannot be cut.

In a rising market, substantial returns can be generated through a concentration of investment in a few areas having the greatest potential. However, in a corrective market, diversification is a better strategy.

With labor costs rising, investors should identify companies — such as those in lodging and oil and gas drilling sectors — that have good pricing flexibility.

3. Consider selecting large-capitalization stocks.

Our overall equity strategy continues to emphasize stocks of companies having relatively consistent and visible earnings growth, and stocks offering total return potential.

Large-capitalization stocks are favored which, in addition to having the above characteristics, have relatively good market liquidity, quality, and financial strength. Once again, your financial consultant can guide you with appropriate recommendations for large-cap stocks.

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