Pop quiz: When did the Dow last drop as much as it did today?
Short answer: Who cares? You’re not selling today, so don’t fret.
Longer answer: The last time was eight months ago, but let’s put things in context. The Dow dropped by more than 800 points today — an amount that definitely catches attention. But in the grand scheme of things, it’s just a blip on the radar.
So, what happened today? Basically, interest rates. Treasury yields have surged lately, specifically the yield on the 10-year U.S. Treasury note. It spiked last month and has continued its rise into October. A rise in yields means higher borrowing costs for corporations and investors. It also makes stocks look less attractive compared to bonds (For the pros out there, higher yields also make stocks look more expensive because of a higher “discount rate.”) On top of that, richer rates of so-called risk-free bonds can attract investors away from equities, which are perceived as comparatively riskier.
Over the past two years, U.S. markets have soared. The Dow Jones Industrial Average gained more than 7,800 points in 2016 and 2017, and has continued rising this year.
Dramatic numbers reported during the volatility of the first days of February kicked off a rockier 2018 than many wanted, but the market resumed its winning ways in fairly short order. And now we’re in another rough patch.
Recent headlines announcing big point-losses sound frightening, and indeed, the Dow has dropped a lot today. But remembering the elevated growth of the last two years can help us put it into context. Even though markets entered correction territory earlier this year (a “correction” is a 10% drop from a recent high), the Dow is still up for the year and dropped by a relatively modest 3.15% today.
As we told you in February when the Dow posted its worst one-day point drop in history, we’re optimistic about overall growth for 2018 but we’re likely to see a bit more drama, especially in a rising rate environment. Volatility is a normal, healthy part of market cycles. Don’t let sensational headlines push you to panic.
In that same piece, we reminded you that since 1900, the U.S. averages about one correction per year. And the stock market has had positive annual returns in 28 of the last 37 years.
With that perspective, if your investing time frame is years or even decades from now, it may be best to hold tight and stay invested. Of course, there’s no guarantee that durations of future recoveries will happen in a similar time, or at all. But unless you have a need for your money in the short term, it might be prudent to just be patient.
By the way, the economy is still doing great. Thanks to cuts in corporate tax rates, earnings are looking good for the third quarter, with a rise of more than 20 percent compared to last year looking likely. That would be the third consecutive quarter of earnings growth of more than 20%, according to FactSet.
This makes stocks the place to be for investors, even assuming higher interest rates.
If you still feel anxiety about recent market volatility, it may be that your investment strategy isn’t aligned with your risk appetite.
“Risk appetite” refers to the amount of investment risk you’re comfortable taking for a particular investment goal. It’s usually based on the time frame for that goal and on your personality and personal preferences.
For example, if you’re investing for the college education of a child who is still a toddler, you will likely have a greater risk appetite and be able to invest in more aggressive strategies because of the long time frame until that money will be needed. You can afford to invest in stocks that fluctuate more — but are also likely to grow more — because you have years to wait out market ups and downs.
But if you’re investing for the education of a child who’s 16 years old, your risk appetite would likely be much smaller; in a few short years, that money will be needed for tuition payments. You can’t risk investing in stocks that are susceptible to volatility in case markets are low when you need to sell and withdraw cash.
When it comes to retirement investing, risk appetite generally tends to be higher for investors who have a long time horizon before retirement, and lower for investors who hope to retire sooner and need their investments to be more stable when they begin to rely on that money for income.
Personality and personal comfort play a big role in risk appetite as well. If you’re investing for a long-term goal but market volatility is still keeping you up at night, you may be investing outside of your risk comfort zone. There’s no “right” level of risk tolerance, just one that’s right for you.
Curious what your risk appetite is? You can take this short quiz to learn your “risk number.”
If your investments have a higher risk level than you’re comfortable with, you should talk to your financial advisor about adjusting your allocation. (You can reach your Azzad advisor at 703-207-7005).
If you have a high risk tolerance and a long enough time frame, a market drop is either something to ignore or an opportunity to buy or rebalance your current portfolio. In a market dip like we’re in right now, rebalancing would mean selling more conservative investments that haven’t dropped with the market and buying more aggressive options while prices are low.
Whatever may be happening in the markets, understanding your personal risk appetite and sticking with a long-term plan that aligns with it are crucial to your success as an investor.