It’s a strange and difficult time to be a stock investor in 2021. The market goes up and down depending on all kinds of news about the Federal Reserve, interest rates, inflation, the Delta coronavirus variant and the capital gains taxes. It’s more important than ever to rely on proven investment strategies to get through tough market times.
1. Don’t panic
This may not seem like a full-fledged strategy, but it is actually the most important. You never want to let fear or the hype control your investing decisions. Fear is a natural reaction to the alarming headlines we see every day. Market declines inevitably hit every now and then, and they are stressful for any investor. Yet we all need to resist the urge to make emotional decisions.
Some investors panicked and pulled out of the stock market in March 2020. We were inundated with information about a pandemic and economic disaster. These people probably missed the boat as markets rebounded quickly and indexes hit all-time highs.
It also works the other way around. Risk is an integral part of investing and nothing is guaranteed. Many inexperienced investors have jumped on the exuberance of stocks and cryptocurrencies this year. A significant number of these people lost a lot of money, and they never even considered the fundamental thesis for the investments they were making.
There’s a good chance the market will drop this year as the Fed hikes rates. Don’t panic if your stock portfolio drops dramatically over the course of a few days or weeks. On the flip side, there is also a good chance that the market will continue to climb over the next 6-18 months as the Fed delays any slowing to keep the economy growing.
Recognize the different possibilities in the market this year and emotionally prepare for the potential gains and losses. Don’t stray from a well-constructed plan when predictable results trigger an emotional response.
2. Diversify, at least a little
Diversification is a good way to dilute risk, but it also reduces your upside potential. I recommend finding a middle ground that creates balance in your portfolio. You can set yourself up for long-term success, regardless of the potential results that materialize.
You don’t have to own hundreds of different stocks or stick with index funds, but it’s not a bad idea to invest in a few different categories this year. For example, value stocks and growth stocks have delivered comparable returns since the start of the year, but they have followed very different paths.
Each category would likely react differently to inflation or higher interest rates than expected, and it’s impossible to know exactly how these variables might play out. Growth stocks had a phenomenal year in 2020 and they charged in the second quarter. However, they have reached historically high valuation levels, which would make them very vulnerable in the event of a market correction.
So how do you deal with this uncertainty? Create a long-term growth portfolio, own value stocks as well as growth stocks and rebalance it within months of changing economic conditions. That doesn’t mean you should make drastic changes to your allocation, but you can mitigate some of the obvious risks today with a few modest adjustments and diversification.
3. Think long term and pay attention to the fundamentals
Imagine your most compelling stock is making fantastic quarterly profits, then losing value because interest rates rise. Does that mean your choice was wrong?
I would say no. You just need a long enough time horizon for this investment to come back into positive territory. You also need a comprehensive financial plan that allows you to absorb these temporary and short-term speed bumps.
You should not rate the performance of your investment on the most recent price movement. Instead, you should think about the fundamentals of the business and your long-term outlook. How much are sales increasing? Are profit margins at the levels you expected? What is the cash flow produced by the company? Is the company earning enough to maintain and increase its dividend? Does the share have a reasonable valuation?
If the fundamental thesis is still strong, then it is still a viable investment, even though market prices have fallen. Make sure you have sources of cash elsewhere in your financial plan so that you don’t have to sell good stocks that are temporarily down. In the long run, you will enjoy positive returns.