Some investors may feel that by maintaining their investments during volatile markets and not panicking they are acting appropriately. While that is certainly a better strategy than selling stocks after a major drop or adding to equities after a significant price increase, there is another approach that can be implemented. This approach is to recognize that after major market moves, your investment mix is likely to be different than its desired range and making some changes could be beneficial.
Investors clearly recognize that if a change is made such as buying stocks and selling bonds, their investment mix is being altered. However, not everyone realizes that during volatile markets, the percentage weightings in different investments can change without making any direct moves. This is called passive re-balancing. For example, in recent months, bonds have performed significantly better relative to stocks, which means that investors are seeing their respective percentages in bonds increase, while stocks decline.
Someone based on their age and risk tolerance may have a desired allocation to be 70% in stocks and 30% in bonds. However, with recent moves in the market that mix may have changed to 63% stocks and 37% bonds. Therefore, an investor would need to sell bonds and buy stocks to get back to a desired allocation. If an investor’s asset mix is within 5% of the desired target, making a change is probably not necessary. This approach allows a person to buy stocks when they are down in price. Conversely, if the reverse was true and stocks were performing better than bonds, one would be selling stocks after they increased in price.
The bigger question for investors would regard whether now is an appropriate time to be adding stocks? The answer is yes, assuming that someone is a long-term investor and can live with the current gyrations in the market. Clearly, every market environment has differences relative to prior periods, but the challenges we currently face are not insurmountable.
Fears of a new recession may be overblown. Economic data for September was fairly stable with recent months and auto sales had one of their strongest readings for the year. Certainly, there are significant risks, as Europe remains a big question mark. However, the stock market does appear to be pricing in much of the potential negative news. Therefore, for a patient investor, the significant price drop in the market offers an opportunity to add to stocks.
