It's a strange and difficult time to be a stock market investor in 2021. The market is moving up and down based on all sorts of news about the Federal Reserve, interest rates, inflation, the Delta coronavirus variant, and capital gains taxes. It's more important than ever to lean on proven investing strategies to navigate challenging times in the market.
1. Don't panic
This one might not sound like a full-blown strategy, but it's actually the most important one. You never want to let fear or hype control your investment decisions. Fear is a natural reaction to the alarming headlines that we're seeing every day. Market downturns inevitably hit from time to time, and they are stressful for any investor. Still, we all need to resist the urge to make emotional decisions.
Some investors panicked and sold out of the stock market in March 2020. We were inundated with news about a pandemic and economic catastrophe. Those people probably missed the boat as markets quickly rebounded and indexes hit all-time highs.
It works the other way, too. Risk is an inherent part of investing, and nothing is guaranteed. Lots of inexperienced investors have jumped on board meme stock and cryptocurrency exuberance this year. A significant number of those 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 that the market dips this year as the Fed raises rates. Don't freak out if your stock portfolio drops significantly over the span of a few days or weeks. On the other hand, there's also a good chance that the market keeps climbing for the next 6-18 months as the Fed delays any tapering to keep the economy growing.
Recognize the different possibilities for the market this year, and prepare yourself emotionally for potential gains and losses. Don't waver from a well-constructed plan when predictable outcomes trigger an emotional response.
2. Diversify, at least a little bit
Diversifying is a good way to dilute risk, but it also reduces your upside. I recommend finding some middle ground that creates balance in your portfolio. You can set yourself up for long-term success regardless of which potential outcomes come to fruition.
You don't have to own hundreds of different stocks or just 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 year to date, but they've followed very different paths.
Each category would likely react differently to higher-than-expected inflation or interest rates, and it's impossible to know exactly how those variables might play out. Growth stocks had a phenomenal year in 2020, and they charged in Q2. However, they've reached historically high valuation levels, which would make them very vulnerable in a market correction.
So how can you manage that uncertainty? Create a portfolio for long-term growth, own some value stocks along with growth stocks, and rebalance in a few months after economic conditions change. This doesn't mean you should be making drastic changes to your allocation, but you can mitigate some of today's obvious risks with some modest adjustments and diversification.
3. Think long term and pay attention to fundamentals
Imagine that your highest-conviction stock reports fantastic quarterly earnings and then drops in value because interest rates are rising. Does that mean your pick was wrong?
I would say no. You just need a long enough time horizon for that investment to return to positive territory. You also need an overall financial plan that allows you to absorb these temporary, short-term speed bumps.
You shouldn't assess your investment performance on the most recent price move. Instead, you should think about the company's fundamentals, and what your long-term prospects look like. How much are sales growing? Are profit margins at the levels you expected? How much cash flow is the company producing? Is the company earning enough to maintain and grow its dividend? Does the stock have a reasonable valuation?
If the fundamental thesis is still strong, then it's still a viable investment, even if market prices have fallen. Make sure you have sources of cash elsewhere in your financial plan so that you aren't forced to sell any good stocks that are temporarily down. Over the long term, you'll enjoy positive returns.
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