Dec. 18 was a big down day in the stock market with the Nasdaq Composite (^IXIC 1.03%) falling 3.6% and the S&P 500 (^GSPC 1.09%) tumbling 2.9%.
The main catalyst for the sell-off was an update from the Federal Reserve that indicated it would slow its pace of rate cuts in 2025, which could keep interest rates high and slow economic growth as a result.
Meanwhile, valuations across the market are stretched, and some investors may be wondering if now is a good time to sell stocks and run for the exits. Here are some lessons worth remembering when it comes to managing your portfolio during times of volatility.
Image source: Getty Images.
Market timing and compounding
In this situation, it’s good to remember this excellent quote from Ken Fisher of Fisher Investments: “You don’t need perfect timing to achieve marvelous returns. Time in the market beats timing the market — almost always.”
The quote is a nod to the power of compounding. For example, take two investors who each start with $10,000. The first person enjoys a 10% return over 30 years. By matching the historical average annual return of the S&P 500, they still end up with about $174,500. Meanwhile, the second person produces a phenomenal annual return of 20% per year, but they only invest for 15 years. Despite outperforming the first investor by a wide margin, they’d end the period with about $154,100.
Now, some of you may look at this math and argue that no one is getting any younger, so while it would have been great to start investing earlier, that ship has sailed. But the lesson of time in the market beating timing the market still applies.
Otherwise, boosting savings can help offset a narrower time horizon. For example, let’s take two investors with the same 10-year time horizon starting out with $10,000 and earning an average return of 10% per year. The first investor puts an additional $500 into their portfolio monthly, whereas the other puts $750 to work every month.
It’s just a $250 difference, or $3,000 per year. But over 10 years, that higher savings rate adds up to a big difference. The $500-a-month investor would end up with $251,800, but the $750-a-month investor would have over $355,000. Their $30,000 in extra contributions grows into more than $100,000 over the decade.
So, when faced with stock market volatility, it’s essential to understand the pitfalls of reacting emotionally and panic selling. The goal shouldn’t be to try to jump in and out of the market but to accumulate shares of quality businesses while letting the power of compounding work in your favor.
The importance of justifying valuation
Compounding only works on growing assets, though. The concept fails if the total return of an investment is negative over time, so selecting quality investments and giving them time to grow is paramount.
For investors who value simplicity, seek out an S&P 500 index fund. This strategy is essentially a diversified bet on the sustained growth of the U.S. economy since the index includes about 500 of the country’s largest publicly-traded companies.
If you’re interested in individual stocks, the key is finding companies you have high conviction in. To do that, you’ll need a clear investment thesis (reason for owning the company), and the company’s valuation must be acceptable to you. Plenty of excellent companies are expensive based on their existing sales or earnings. When you pay the premium to own them, you have to be confident in the company’s ability to continue growing their sales and earnings going forward.
In general, the more a company’s valuation is based on future results, the more likely it is to be volatile as the market sentiment toward those results changes. Put simply, growth stocks tend to be more volatile than value stocks, for example. Even at an index level, the the tech-heavy Nasdaq Composite usually outperforms the S&P 500 and Dow Jones Industrial Average during bull markets and underperforms them during market sell-offs.
Everyone has a different appetite for risk, and your portfolio should balance that risk with your investing goals and time horizon.
Take ownership of your portfolio
One of the biggest mistakes investors can make is overhauling their portfolio due to short-term volatility in the market like what happened last week.
By focusing on factors within your control, identifying (and personalizing) your portfolio’s exposure to risks and opportunities, and maximizing your savings, you can stay the course whether the market is reaching new highs or in a tough downturn.
