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Five ways of dealing with market volatility
With the current pandemic, the financial markets are displaying a degree of volatility that the past decade has not prepared us for. Here are five possible ways of coping with these unprecedented circumstances.

Faced with the anticipated effects of the COVID-19 pandemic and falling oil prices on the global economy, financial markets went into a sharp decline at the end of February. A month later, we saw them rebound as governments announced economic support measures. Where do we stand today? The following graph, based on the Canadian stock market, provides a snapshot as at March 30, 2020.

 

Line graph showing the performance of the S&P/TSX index over the past 25 years. The curve takes a sharp plunge in early 2020, but shows substantial growth over the long term.

 

As shown by the graph, the S&P/TSX index tumbled from a peak of 17,944 points on February 20 to 13,039 points on March 30, a drop of about 25%. With other stock market indices falling by at least as much, many individuals have seen their portfolios drop in value since the beginning of the year.

The following approaches might help in coping with this situation.

1. Look to the past for perspective

While no one knows when the current period of volatility will end, it may be instructive to examine other market crashes from the past. Recently, the USA Today website catalogued 17 such episodes since the 1900s. Here are a few telling examples from that list. As we can see, even if the COVID-19 pandemic is unprecedented, market declines like the current one are not unusual: they are a part of the financial market dynamics.

 

Table summarizing a number of stock market crashes from the past century. The worst downturn was in 2008. At that time, the Dow Jones index dropped by 53.7% overall and by 4.6% in a single day. In 1929, the DJIA dropped by 46.6% overall and by 12.8% in a single day.

 

2. Remember that you have a plan

In principle, a portfolio is built with reference to the investor’s risk tolerance. Risk tolerance is generally determined using a questionnaire that asks, among other things, what level of price fluctuation the person is willing to accept. For example, if someone responded that they would be willing to accept losses of 36% in exchange for the possibility of gaining 42% over the course of a given year (which would rank as highly volatile), the current volatility level would probably fall within the guidelines of this person’s plan. In practice, most investors have a more balanced portfolio. A useful initiative might be to go back to your plan, check the targeted risk level and confirm whether it is consistent with the actual fluctuations of your investments.

For more information about the concept of risk tolerance, have a look at this infographic.

3. Don’t give in to fear

There’s a saying that the markets are driven by two opposing emotions: fear and greed. Fear tends to prevail when the markets begin to plummet. In today’s context, fear could make investors want to “stop the bleeding”. But doing so would also mean realizing their losses, while the markets have a history of always rebounding after a serious downturn, sometimes spectacularly. So it could be wiser to wait a few months instead of pushing the panic button.

That said, certain individuals might consider realizing some investment losses as part of a strategy aimed at reducing their capital gains tax. Advice from tax specialists is strongly recommended here.

4. Don’t give in to greed

Conversely, an investor with liquid assets might be tempted to take advantage of the current low prices to invest heavily. There’s another saying that warns against giving in to that temptation: don’t try to catch a falling knife. The reason for this is that no one knows when the markets are going to bottom out or when they’ll start to recover. Even though today’s environment might seem to offer a great opportunity, experts generally recommend against making a single purchase in favour of incremental purchases at intervals so as to end up with an attractive dollar-cost average, no matter what happens to the markets over the short term. Generally speaking, it would seem best to maintain a constant presence in the market rather than trying to guess when to get in or out. In this regard, a study published recently by Morningstar shows that an investor who was out of the Canadian stock market for just the best two days between 1977 and last February would have missed out on 19% in returns.

5. Secure the short term while safeguarding the future

Many people now find themselves in a difficult financial situation. In this context, it would be understandable to address short-term needs first and put savings “on hold”. However, if finances still permit, it might be better to stick with the original plan, given that time is the key ingredient in a successful savings strategy. It might be advisable to use one of the many aid programs announced for individuals and businesses, in the hope of being able to continue investing at least as much as you can.

Finally, some information for those who make RRIF withdrawals: don’t forget that the government has reduced the minimum withdrawal for 2020 by 25%, which could also result in tax savings for the individuals concerned.

 

The following sources were used to prepare this article:

Advisor’s Edge,Liberals ease minimum RRIF withdrawals as part of pandemic response.”.
Forbes,Three Things To Do During A Stock Market Crash”.
Government of Canada,Maladie à coronavirus (COVID-19)”.
Investment Executive,From 1987 to 2020: perspectives on bear markets”.
Investopedia,Smart Strategies for a Bear Market”.
Morningstar,When FOMO is warranted”.
Ohio’ 529,Risk Tolerance Questionnaire”.
Trading Economics,Canada S&P/TSX Toronto Stock Market Index” ; “S&P 500”.
USA Today,How the current stock market collapse compares with others in history”.
U.S. News,7 Tips to Stay Calm During a Stock Market Crash”.
Wikipedia,Greed and fear”.