Did the recent stock market volatility put you on edge?
X It’s understandable, of course. But that doesn’t mean you should panic and unload your ETFs and/or mutual funds when the market falls. In fact, it could be an opportune time to add to your positions.
First, consider your holdings. Are they diversified or sector plays? Sector funds can be a bit trickier, since they are more concentrated and can thus be prone to a steeper drop. A diversified ETF will tend to fare better during a market pullback, since it is spread across various sectors.
Next, review your objective. If you are in the funds for the long haul, you should think twice before selling shares.
The market itself carries risk. Interest rates, corporate earnings, economic cycles and news events can affect the market as a whole, and diversification only offers you some cushion. When the market takes a hit, whether you have 10 stocks or a thousand, you will most likely see losses. Diversification doesn’t protect you from taking losses, it just means your losses might not be as bad.
However, if you sell when you just can’t take the pain anymore, you also lose your opportunity to participate in the recovery. All too frequently, investors in diversified funds sell at the absolute wrong times. That can degrade your long-term performance significantly.
For longer-term mutual fund and ETF shareholders, a buy-and-hold mentality makes sense. Consider dollar-cost averaging. This strategy will help you avoid missteps in trying to time the market. By investing a fixed amount on a regular schedule instead of a lump sum, investors can build a stake gradually while smoothing out any big ups and downs in share prices.
So let’s say you buy shares of an ETF or mutual fund each quarter over a one-year period. You’ll get more shares when prices are lower and fewer shares when prices are higher. In a falling market, the average cost you pay for shares gets lower and lower. That often works out to your advantage over time. Now in a rising market, your average cost will go up. But if you have a long-term horizon, it still makes sense to add shares at regular intervals instead of trying to time your purchases.
IBD’S TAKE: The stock market has been very volatile lately. Read our cover story on why stocks sold off and what you should do now.
Another strategy to lower your overall cost, particularly with ETFs, is by adding shares when they pull back to the 50-day or 10-week moving average. ETFs often stage bigger moves on rebounds off support lines than out of breakouts from bases. So you could increase your stake by buying on the dips as long as the fund is in an overall uptrend.
Individual stocks should be handled differently, because in addition to market risk, they have company-specific risks. For instance, an earnings miss, an acquisition or FDA rejection are just a few reasons a stock could tank. Whereas the market as a whole has always recovered over time and gone to new highs, many individual stocks never come back. One IBD study showed that only one of eight former market leaders go on to lead a future market cycle after a major correction.
“A well-selected, diversified domestic growth-stock fund run by an established management organization will, in time, always recover from the steep corrections that naturally occur during bear markets,” IBD founder and Chairman William O’Neil said in “How to Make Money in Stocks.” “The reason mutual funds come back is that they are broadly diversified and generally participate in each recovery cycle in the U.S. economy.”
Here are the five most common mistakes fund investors make, according to O’Neil:
1. Failing to sit tight.
2. Worrying about a fund’s management fee, its turnover rate, or the dividend it pays.
3. Being affected by news in the market when you’re supposed to be investing for the long term.
4. Selling out during bad markets.
5. Being impatient and losing confidence too soon.