In a span of just three trading days, the sector of the S&P 500 that tracks financial companies tumbled 9.3% amid a banking crisis sparked by the collapses of Silicon Valley Bank and Signature Bank. That crisis appears to be contained, at least for now, thanks to quick intervention by the FDIC and the Federal Reserve. Still, both new and seasoned investors have been rattled by the rapidly shifting market.
So far this year, nearly half of trading days have seen the S&P 500 Index post daily moves in excess of 1% higher or lower, which is often characterized as volatility. But that’s actually “natural” given that this benchmark remains in a bear market, says Sam Stovall, chief investment strategist at CFRA Research. In fact, since World War II, only 15% of trading days during bull markets experienced moves in excess of 1% compared with 45% of trading days during bear markets, he adds, citing his research.
Not only does the S&P 500 remain in a bear market because it has yet to fully recoup its losses, there are other factors beyond the banking crisis contributing to market volatility. “In my year ahead outlook for 2023, I called it a tale of two halves,” Stovall says, adding that he believed the first half of the year would be marked by volatility as the end of the Federal Reserve’s aggressive policy to raise interest rates works out.
Even if volatility is expected at some level, it can still be unsettling to investors — and particularly when people make comparisons to the Great Recession. Here’s what you need to know about how to invest during periods of volatility.
Why diversification can help during periods of volatility
That slump in financial stocks surrounding the bank collapses earlier this month illustrated an important point: Some events ripple across the 11 sectors of the S&P 500 in different ways. While financial stocks fell more than 9%, the broader S&P 500 was down 3.4% during the same period.
That’s why it’s important to have a well-diversified portfolio so you don’t have concentrated risk in any single sector or stock. “The importance of diversification in your own portfolio” is the message that Northwestern Mutual has tried to impart to clients not only in recent weeks, but over the past year-plus amid a deterioration in the macroeconomic outlook, says Matt Stucky, senior portfolio manager.
If you hold individual stocks, a diversified portfolio might mean something in the range of 40 to 60 stocks, Stucky says, adding that sector representation still matters. “Just because you have 30 securities, if they’re all in the financial sector, for example, you’re not diversified.”
Because building a well-diversified portfolio may be unwieldy for many investors, Stucky instead recommends that a majority of your stocks exposure might be in the form of an index fund, such as an exchange-traded fund (ETF) or mutual fund, mixed with a handful of individual stocks.
Resist the urge to make sweeping portfolio changes
According to Stovall, investors have been battered by “a perfect storm” of concerns ranging from the banking crisis in the U.S. and abroad, along with debate about how the Federal Reserve will adjust its benchmark rate, the federal funds rate, at its meeting this week. Rather than trying to brave the storm and make changes to your portfolio, the best course of action is typically to hold tight, he adds.
“While investors might be tempted to [time the market], remember that by doing so they will have to be correct twice — once while getting out and again while getting back in,” Stovall says, adding that most investors wait too long to reinvest in the stock market.
Likewise, Stucky says the urge to do something during periods of volatility is understandable, even though it doesn’t typically work out in the favor of investors.
“Investing in general requires a degree of humility as you approach the portfolio,” he says. “We don’t know the future with certainty and the best way you prepare for uncertainty is to not concentrate your assets in something that you think might be safe or you might think might give you a little bit of a relief over the next couple of quarters, when it could over the long run cost you a significant portion of your wealth.”
If you do feel the need to be proactive during periods of volatility, there are some basic portfolio maintenance exercises you might consider, Stucky advises. Those include reaffirming the amount of risk you’re comfortable with in your portfolio, checking that you’re indeed diversified across a variety of asset classes and geographies, rebalancing your portfolio, and avoiding making withdrawals at an inopportune time, he adds.
Finally, reverse psychology — namely viewing market downturns as an opportunity — may also help, Stucky says. Coming up with a buy list for individual stocks of high-quality companies that you would love to own at a price that you think is “absolutely ridiculous” and then place a limit buy order with your broker that will only be executed at that level or lower, he adds. “Things like that are also ways to change behavioral thinking.”
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This article was originally published on SFGate.com and reviewed by Lauren Williamson, who serves as Financial and Home Services Editor for the Hearst E-Commerce team. Email her at lauren.williamson@hearst.com.