Inflation is driving the headlines and wreaking havoc on budgets. But for long-term investors – volatile markets are also in focus. It's fueled by the Federal Reserve's efforts to balance bringing down inflation with keeping the economy out of recession.
The Fed is raising the key short-term interest rate to slow economic growth. This makes accessing money through credit more expensive. The obvious example is mortgage rates, which are 5.87% on average as of June 14th.
One reason inflation and higher interest rates generate this volatility is that markets hate uncertainty. Markets are forward-looking and attempt to price into stocks and bonds today, things that will likely happen in the future. The issue is that the Federal Reserve can't tell the markets in advance exactly how much and when they will raise interest rates because it's a delicate task depending on a lot of ever-changing economic data. And let’s be honest, probably some guesswork.
The Fed members try to be forthcoming and transparent about their thinking. One thing they keep saying over and over is that their decisions will be data-dependent. In other words, they aren’t entirely sure what path this will take either.
So, how do you cope with the uncertainty and volatility as an investor? We have some pointers.
Don’t Stop Thinking About Tomorrow
As I write, I can hear the lyrics in my head:
Don't stop thinking about tomorrow
Don't stop, it'll soon be here
It'll be better than before
Yesterday's gone, yesterday's goneFleetwood Mac
Just because the market is down now does not mean you should stop saving and investing for your goals, particularly for long-term goals like education, retirement, or healthcare later in life. These types of savings are often tax-advantaged, so you aren't just putting money away; you are potentially lowering your taxable income – and taxes – in the year you make contributions.
- 529 plans grow tax-free and may have state tax benefits
- 401(k) and IRA savings receive tax deductions and grow tax-deferred
- Health savings accounts (HSAs) are triple-tax advantaged – they reduce your income, grow tax-free, and qualified withdrawals are tax-free
We get that you may feel that every dollar you put into these accounts is just going down, but remember, the best times to buy are when the markets are down. Buy low, sell high.
Will This Matter in Five Years?
It's painful to look at statement balances. But history tells us that markets do recover. Historically there have been just four times when a standard 60/40 diversified portfolio was negative over the course of five years, and those were all around the great depression years. While it may not be as quick a rebound as 2020’s market crash, over the long-term, downturns have been followed by gains. If you stay in the market, your persistence will likely be rewarded. If you sell, you turn a paper loss into an actual loss.
One way to stay focused is to think about your goals. Your plan has likely incorporated your risk tolerance. This is the balance of the growth you want with the drawdown potential you feel comfortable with. Your investments are mapped to your goals. If your plans haven't changed, your investment strategy shouldn't either.
Diversification Still Matters
Inflation likely resulted from three things: stimulus to help the economy (and Americans), disruptions to the supply chain, and a war in Ukraine.
The traditional way to diversify against just stocks is by using bonds. This year bonds have struggled as interest rates rise but have not fallen as much as stocks. Remember that bonds may have a role to play in reducing volatility. Bonds generally have much lower volatility than equities, which can help moderate stock ups and downs. They are still valuable in portfolios.
Being diversified amongst asset classes and sectors is important as well. For example, gold and silver, along with broader-based commodities, which have trailed the markets dramatically over the last ten years, have generally held up well this year. Having assets that act differently from each other during different periods gives diversification that helps smooth portfolios over time.
The Bottom Line
Volatility isn’t comfortable for anyone. There’s a reason that the index that measures market volatility – the “VIX”-- is called the “fear index.” But that doesn’t mean you have to succumb to the fear. Take stock of where you are, keep an eye on the future, and tune up your portfolio based on changes in your life where necessary. We are here for you if you need help or want to talk.
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