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Q&A: Investing in Volatile Markets
Q: The Nasdaq has declined significantly over last year's highs. What would you tell investors who have watched the value of their portfolios slide with the downturn in the Nasdaq?
A: The stock market is a volatile animal. History tells us that roughly once every two years since 1970, we witnessed a decline of 10% or more. In fact, we've had four 10% declines in the last four years, and one already this year. That's simply the nature of the animal, and trying to predict its direction over the near term is an exercise in futility. Behind all the smoke and noise on the market's surface, it's important to remember that companies – small, medium and large – make up its backbone. And corporate earnings drive stock prices. If you look at the 500 stocks in the S&P 500®, despite 9 recessions since WW II, earnings have grown 9% annually. That's a pretty good track record. The recent volatility we've seen can be compared to a long airplane ride – you're bound to hit some turbulence along the way. Knowing what investments you own and why you own them is like fastening your seatbelt to prepare for the bumpiness.
Q: What is the official definition of a bear market and are we in one now?
A: Well it can vary, but it is generally considered a decline of 20-25% from a previous market high. So, by most measures, we've entered bear market status – the S&P 500 Index passed that mark on March 12 (down to 1180.16 from a high of 1527.46 on March 24, 2000). The Nasdaq has been in bear territory for a while now. Q: You have said volatile markets underscore the need for diversification. Has anything changed that would alter your position on diversification?
Q: You have said volatile markets underscore the need for diversification. Has anything changed that would alter your position on diversification?
A: Diversification has and always will be a critical component to investing responsibly. Here's an example: Of the 21 years in which equities have had negative returns, medium-term government bonds had positive returns in 19 of them. I'm certainly not saying that bonds perform better than stocks, because we know over time that it's not the case. But it makes a pretty good argument for diversifying into a wide range of equities, bonds and other asset classes if you think the market is in for tough times. And don't get caught in the trap of false diversification within equities. A lot of people bought a number of technology funds and technology stocks but that constituted their entire equity holdings. When the Nasdaq declined, all those equity holdings went down together.
Q: You always say to invest for the long-term. What do you mean by long-term investing?
A: A lot of people think long-term investing is three weeks from next Wednesday, but when I talk about long-term investing I mean staying in the market for three, five or 10 years. During that length of time the market can experience ups and downs due to what I call "background noise." Events occur – hurricanes, wars, and international crises like the Brazil currency devaluation or Russia defaulting on its debt – that make investors nervous and cause market volatility. It does get nasty at times, but it shouldn't cloud investors' judgments about thinking long-term. The key organ here is your stomach. Everyone has the brainpower, but not everyone has the stomach for it. Q: Any parting thoughts for investors?
Q: Any last thoughts for investors?
A: A couple of things. First, if you're going to need money within 12 months to pay for college tuition or put a down payment on a house, the stock market is not the place to be. You can flip a coin over where the market is headed over the next year. But if you're in the market for the long haul – 5, 10 or 15 years – then time is on your side and you should stick to your long-term investment plan. Second, I have no idea whether the next 1,000 points for the Dow or Nasdaq will be in positive or negative territory. But I would argue that the next 10,000 points for each will be up, as will the next 20,000. The bottom line is to spend time getting to know your investments. There's too much at stake not to.
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