Five key rules to investing wisely in volatile markets

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Investing during a volatile market can be intimidating. Large, daily price swings often lead to emotional decision-making and flawed judgment. Erratic market behavior can make even the most seasoned investors nervous about their portfolio holdings. When investing during a volatile market, invest wisely by keeping yourself rooted to these rules.

Before doing anything, secure your emergency fund

The first step has nothing to do with investing. Yet, this is the most important part, especially during volatile markets. It is crucial to have a six-month fund of necessary expenses (housing, bills, food, etc) stashed away. You’ve heard this before, but let’s talk about how it relates to investing.

Many have painstakingly learned in 2020 that anything can happen. Millions have lost jobs and entire industries have been turned upside down. This led to extremely volatile markets in which we have some seen market caps cut in half. This has had extreme negative effects on people that were not prepared.

Those that may have lost a job and had to liquidate investments to cover expenses may have only received a mere 60% or 70% of what they would’ve been able to draw one month prior. By selling and realizing a loss they’ve locked in their losses instead of having the flexibility to wait for stocks to rise again.

Situations like this magnify the importance of the emergency fund. Not simply from a personal finance perspective, but from investing as well. Before committing funds to your investment account you should be prepared to live without that cash for the foreseeable future.

Opportunities come along. Cash is king.

Don’t confuse this with the preceding text. From the standpoint of your investment portfolio, the cash in your emergency fund can not be touched. Nothing. Does not exist. What I am talking about here is the cash in your investment portfolio. 

Volatile markets bring quite an array of challenges, but with the right positioning challenges become opportunities. Cash is an extremely important tool that gives you the ability to act on opportunities. As the old saying goes, cash is king, and investing during a volatile market is the perfect time to test this theory. 

Having cash on hand gives you the ability to execute on an opportunity by purchasing shares of a company while it is “on sale”. Even if you currently maintain a portfolio and some of your positions declined in the short-term, you are able to buy in for a lower price and enter a position at a lower cost basis. This is what allows prepared investors to take advantage of downturns and come out with a better-positioned portfolio.

Opinions will differ, but it’s usually suggested to keep 5-20% of your portfolio in cash. (Obviously there are many factors here, so take this with a grain of salt and consult with a financial advisor.) 

Don’t try to time the market

It is impossible to know exactly when something is going to bottom out or hit an absolute high. Technical analysts will produce charts and figures on moving averages, relative strength indices, etc, but no one can predict the future. Rather than attempting to time a market low, stick to a routine.

A common method is dollar-cost averaging. This is simply the practice of dividing your allocable funds for a position over time and entering at defined intervals. For investors that set aside a certain amount each month to invest, this concept is particularly effective. Rather than attempting to time the market and possibly succumbing to emotional pressures, using a simple formula like this usually is much more effective over time. This eliminates the common problem of “waiting until the right time” (which usually results in missed gains).

Stick with what you know

Investing in a volatile market is not a time to be adventurous. You may be surprised, but this can be more difficult than you’d think. Volatile markets always include increased news attention and overall “jitter”. There are more micro influences during these times and everyone seems to become professional investors or economists overnight. Stock market talk will creep into conversation more and more among friends and at the dinner table.

With increased attention to the markets and large swings, you’re bound to see extraordinary returns, and collapses. Take Eastman Kodak Company (aka Kodak, the analogue photography company). After a potential $765 million contract was introduced for the company to produce an ingredient used for COVID-19-related pharmaceuticals, the company immediately pushed a press release that sent the stock flying. KODK closed at $2.13 per share July 23rd before jumping to $33.20 six days later on July 29 (a 1458% gain). By closing Friday, Aug 21, it had fallen down to $6.88 per share. 

Similar situations arise during volatile markets and can be easy to fall for, but this is where it’s important to stick to what you know. Yes, it may be hard to sit out on some of these as they’re rising, but you’ll be satisfied when you see your portfolio continuing to outshine in the long-term by not being susceptible to these influences. 

Another point on this topic is the move to alternative financial instruments and markets, such as options, futures or foreign exchange. Similar to above, there will likely be increased influences that may drive you to consider pursuing enhanced returns. This is absolutely not the time to devote any attention or funds to a new venture in complex instruments. These are complex and take months, if not years, of research to learn and practice.

Remember the basics: Shop for deals

The best thing about declining stock prices? Deals, deals, deals. Benjamin Graham and Warren Buffet, two wildly successful and enduring investors, heavily reinforce this concept of value investing. As a value investor, you should be searching for quality companies that are poised to have future growth and positive cash flow. In addition, it’s best to find these companies on sale, AKA when the stock price and accompanying market cap may be under the intrinsic value.

Volatile markets may be characterized by large swings, but sometimes they do provide opportunities to invest in quality companies at a lower price. For investors that have a bit of cash on hand, this can be the right time to buy ownership in those companies.

Final Thoughts

Investing isn’t easy, especially in volatile markets. That’s why it’s important to have a plan and stick to it. Investors that follow their blueprint and aren’t swayed too much by external influences will often come out better than ever. 

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