Volatility is rarely fun for investors, but past experiences can help us keep our emotions in check.
The one-year price chart for the S&P 500 demonstrates the sharp increase involatility investors encountered in early February.
Source: Screen capture of the S&P 500 Index (^SPX) from S&P’s CapitalIQ
It’s never fun when stocks fall sharply, unless you’re a short seller betting that prices will decline. And no matter how hard we try to be rational, long-term investors, turbulent times bring out the raw human emotion of fear.
“Is the worst of it over? When’s it going to end? Is this the start of the next big crash? Should I sell everything and hide the cash under my mattress?”
If you’ve felt anxious or scared recently, you’re not alone. Questions like these run through everyone’s head, even the most experienced professionals. But professional investors, whether it’s your financial advisor or your fund manager, can help you navigate the choppy waters and make good decisions during times of uncertainty.
At Motley Fool Asset Management, we’ve experienced plenty of volatility over the years. Here are some ways we’ve learned to handle it.
I remember the price declines in 2008 and 2009 vividly, when it seemed no one wanted to buy. Those were gut-wrenching times where I was tempted to throw in the towel. And the recent drawdowns in 2010, 2011, 2012, 2015, and early 2016 weren’t very much fun, either.
Have you noticed a pattern? Abrupt declines happen somewhat regularly. And whenever stock prices fall, it’s important to stay as calm as possible. Research has shown that we feel the pain of loss 2 to 3 times more than we feel the joy of gain. That added stress could cause investors to make poor decisions. So when prices are falling, even though it’s easier said than done, we find the best thing to do is to take some deep breaths and maintain our composure.
Assess the situation
Staying calm prevents us from making impulsive and possibly bad decisions. It also enables us to rationally gather information and assess the situation properly.
Sometimes stocks fall for fundamental reasons. For example, Chipotle Mexican Grill recently released its fourth-quarter earnings report, and the stock declined sharply, as investors were unhappy with the progress of the turnaround and the company’s current and projected sales growth. For investors to make the best buy, sell, or hold decision with Chipotle, they would have to compare the new information with their previous research to estimate whether enough reward is still available to weather the risks.
Buy quality at the outset
Controlling our emotions is always important, but especially so when volatility increases. One tactic the Motley Fool Asset Management team uses to make dealing with volatility a little easier is to fill our funds with high-quality companies.
Academic research shows that quality companies tend to move through rough patches pretty well. They’re not immune to drops, but sometimes their stock prices don’t fall as far as the market does. And many times they recover more quickly than the broader markets do.
Take a look at the year-to-date performance of our Small-Mid Cap Growth Fund (TMFGX) through the market drop.
Source: Google Finance
When market volatility ramped up starting on Jan. 26, the fund didn’t fall quite as far as the Russell 2500 Growth index. And as the market started to move higher, the portfolio recovered a little more quickly than its benchmark. It doesn’t always work perfectly, but we believe the quality of the companies in the portfolio helped investors navigate the rough patch.
No one wants to see his or her stocks or funds fall. However, it’s a fact of life in investing that prices are going to fluctuate over time. And the more prepared we are to deal with this inevitability, the better our chances are to make good investing decisions during volatile times. The investing team at Motley Fool Asset Management wants to share its experience with you. So remember, during the next period of volatility, don’t panic, assess the situation, and understand that a portfolio of high-quality companies should help you see it through.
The Small-Mid Cap Growth Fund changed its name from The Great America Fund on December 31, 2017.
*The Small-Mid Cap Growth Fund changed its benchmark from the Russell MidCap Index and the Russell 2000 Index to the Russell 2500 Growth Index on Feb. 28, 2017.
For a standardized list of performance for the Small-Mid Cap Growth Fund, please click here. For fund holdings, please click here.