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Three principles to safely navigate the stock market storm.

Panicking in the face of a bear market can cause investors to deviate from the path to achieving financial goals.

Stock markets always experience various uncertainties. Although the current turbulent period is making investors very nervous, in the long run, investors who learn to accept uncertainty tend to win in the end. Panicking in the face of a bear market can cause investors to deviate from achieving their financial goals.

During periods of intense stock market volatility, investors must remember three experiences that can help them stick to their investment plans. For investors who have not formulated a plan, the author also has a suggestion.

1. Economic recession is not a reason to abandon stocks.

Is the US economy heading into a recession? A century of economic cycles tells us that before economists make judgments, the economy may already have entered a recession.

However, the stock market remains one of the best indicators for predicting the direction of the economy. The market often falls before an economic recession and begins to rise before an economic recovery. During an economic recession, stock market returns are usually positive.

In years of economic contraction in the USA, the performance of the US stock market still outperforms low-risk US treasury bonds, illustrating the forward-looking nature of the market. If you feel worried, other investors will feel worried too, and this uncertainty will be reflected in stock prices.

Regardless of whether a stock market decline is accompanied by a recession, the decline itself can make investors feel uneasy. However, over the past century, the US stock market has shown positive average returns in the one-year, three-year, and five-year periods after experiencing sharp declines.

After the S&P 500 index enters bear market territory (defined as a 20% decline from previous highs), the index has historically rebounded by around 20% one year later, with an average rebound of over 70% five years later.

What investors should do is continue to invest and benefit from the upcoming economic recovery. If investors decide to remove stocks, a risky asset, from their investment portfolio, this should be a strategic choice rather than a tactical one. The only reason to sell a stock investment portfolio now should be if investors have learned something about their risk tolerance or if investment goals have changed.

2. Timing decisions can be painful for you.

When the stock market falls, investors may feel compelled to sell stocks to avoid further losses. Some may think, "I plan to stand aside until the market conditions improve." However, when market volatility decreases, these investors often miss out on some rebounds. While it is tough to watch one's investment portfolio shrink, investors can also imagine how it would feel to have their portfolio stagnant when the market rebounds.

It is difficult to predict when high returns will occur, and it is best not to miss them. If an investor continuously invested $1000 in the S&P 500 index from the early 1990s to the end of 2020, they would receive $20451. If they missed the highest return day, they would only get $18329, and if they missed the five best-performing days, they would only get $12917.

History shows that the stock market often rebounds quickly, but the situation for individual stocks or even entire sectors is different. Therefore, while investing involves taking some risks for expected returns, investors should try to minimize risks as much as possible. Diversification is the best way to reduce risk, as well as investing in fixed income and creating financial plans.

Now is a good time to reevaluate investment portfolios and plans.

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If investors can name all the stocks they hold, it means they have too few. Besides USA stocks, how many stocks from other countries are in the portfolio? About half of the global market is made up of stocks from other countries. Missing out on half of the investment opportunities by only investing in the s&p 500 index. Instead of chasing sectors that have performed well in the US stock market in recent years, it's better to create a market-cap-weighted global equity portfolio.

To outperform the large cap stocks, investors can refer to decades of academic research. In the long term, portfolios focusing on small cap stocks, value stocks, and companies with strong profitability have higher returns. The author's portfolio includes over 10,000 stocks from more than 40 countries.

Apart from well-designed investment portfolios, one of the best ways to deal with volatility and low returns is to plan carefully. Financial advisors can help investors create a plan to cope with potential market downturns. They can help investors regain confidence and weather the current storm.

In challenging market environments, creating plans, designing investment portfolios meticulously, and seeking the help of financial advisors is the best way to 'take care of yourself,' and your future self will thank you for doing so.

The author of this article, Marlena Lee, is the Head of Global Investment Solutions at Dimensional Fund Advisors.

Article by Marlena Lee

Editor | Guo Liqun

Original article from Barron's China, unauthorized reproduction is prohibited. The English version can be found in the MarketWatch report "Opinion: Follow these 3 crucial lessons for weathering the stock market’s storm" on May 28, 2022.

(This article is for reference only, investment advice does not represent the bias of 'Barron's Magazine'; the market carries risks, investment should be cautious.)

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