January 24, 2022

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Why You Should Stay the Course With Your Mutual Funds

With the ripple effects of the pandemic-induced market sell-off, we’re facing a hard and fast decline in economic activity. Until the economy rebounds, some investors will be wary of how to treat their mutual fund investments.

Understandably, volatility is an inherent part of investing — but emotions can run high when asset valuations are fluctuating, and investors who experience loss can be led down a path to irrational decisions.

Here’s what a disciplined mutual fund investor needs to know to manage risk while generating growth:

— The advantages of mutual funds.

— When to sell a mutual fund.

— Actions to take during volatility.

Advantages of Mutual Funds

Since there is a lot of uncertainty in the markets today, it’s important to safeguard your index funds through a simple strategy called diversification: It’s a technique that limits exposure to any one type of asset, which ultimately helps maximize returns in the long term.

Mutual fund diversification is the best way to succeed in a recession. Offering a mix of hundreds and even up to thousands of securities to manage risk makes mutual funds an inherently stable investment in a volatile environment.

“As Nobel Prize-winning economist Harry Markowitz noted, ‘Diversification is the only free lunch in finance.’ It allows investors to lower their portfolio’s risks without sacrificing the potential for returns. This will make it easier for them to weather downturns and stay invested,” says Max Gokhman, head of asset allocation at Pacific Life Fund Advisors in Newport Beach, California.

To mitigate your risk exposure, reposition your mutual fund by allocating your investment in different asset classes. Soren Godbersen, vice president at EquityMultiple in New York advises, says by diversifying your holdings in different securities, you can decrease volatility while increasing performance.

“Long-term, stable portfolio growth and guarding against volatility are both about asset allocation. Investing in asset classes that are uncorrelated with public market returns — like private real estate — is paramount.

Individual investors can access a greater breadth of alternative assets and more closely mirror the portfolio allocations of institutional investors like pensions and college endowments, which tend to outperform public markets throughout cycles,” Godbersen says.

[See: 7 Signs it’s Time to Sell an Investment.]

Sell or Stay the Course in a Recession

Mutual funds are known as a type of investment to buy and hold, so it’s standard practice to not sell your mutual fund during a bear market.

It’s normal for investors facing both uncertainty and risk to want to protect their mutual funds from volatility, but some think selling off now and getting back in when the market is lower is a viable option. This abrupt move is a big risk that can likely lead to irreversible losses.

The issue with the market sell-off is it’s difficult to predict when the market has reached its peak or when it has hit rock bottom. Investors who feel forced to sell usually end up buying high and selling low, the highest-risk and worst investment strategy.

[SEE: Coronavirus Affects Businesses Around The U.S.]

Michelle Connell, chartered financial analyst and owner of Texas-based Portia Capital Management, understands that even experienced investors can let fear get the best of them during periods of volatility.

“During the Great Recession, it took seventeen months for the S&P 500 to lose 57%. When the bottom occurred in March 2009, investors were worn out and scared of losing more. It wasn’t unusual for investors to cash out. However, within two years, the S&P 500 had recovered 85% of what it had lost.” Connell says.

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Connell recounts investors who kept waiting to get back in the market, missing out on the most profitable bull market in history. She points to the S&P 500, which gained more than 400% between March 2009 and February 2020.

This example shows that selling in this environment doesn’t make sense if you’re investing in the long term. It’s not a wise idea to sell your mutual funds according to stock price changes; rather, the desire to sell should come when life changes arise or if you plan on reducing risk.

Connell says there are other exceptions for an investor to sell their mutual fund: “If an investor does not have enough funds to cover living expenses in a liquid and safe money market, or in checking or savings accounts, then enough should be sold to cover at least a few months.”

One scenario when you should consider selling a mutual fund is if you’re risk tolerance has been compromised.

When risk tolerance lowers, more bonds should be added, Connell says.

[7 Stocks to Sell to Survive a Bear Market.]

Actions to Take During Volatility

A majority of investors can’t and don’t want to sell but are still uncomfortable with volatility. The reality is we have no control over market activity. But Carolyn Kelly, a certified financial planner at Team Hewins in Redwood City, California, recommends focusing on what can be controlled — how much risk is taken on in your portfolio.

“One of the areas that we have the most control over is our spending. Spending over investment returns will have the biggest impact on the success of your plan. And unfortunately, most of us don’t truly know how much we are spending. While we all shelter in place, I think this is a great opportunity to take a look at this,” Kelly suggests.

It can be difficult to estimate spending amounts, but Kelly advises this is a step in the right direction.

“If you do most of your spending on your debit or credit card, dig up your annual spending summary. It is a great starting point as they usually categorize your expenses for you.”

In the short term, those who are uncomfortable with volatility should ignore the daily fluctuations in the market. Those who are fortunate to still have jobs should keep making contributions to your 401(k), says Robert Johnson, professor of finance at Creighton University in Omaha, Nebraska.

“If your time horizon is long, you should follow the coronavirus refrain and ‘don’t touch your face’ or your 401(k),” Johnson adds.

Ultimately, there are two components that impact your investing strategy: your time horizon and risk tolerance. If your mutual fund valuations are decreasing, Johnson favors reducing your mutual fund shares in stocks to decrease volatility in your investments and increasing exposure to bonds.

“If one finds themselves in a position with an uncomfortably large exposure to stocks, the decision to reduce equity exposure in a downturn is contingent on how comfortable the individual is with risk,” he says.

The pandemic has come as a shock to economic growth, but emotions need to be removed from how investors manage their portfolios. Despite the stock market’s volatility, knowing a diversified mutual fund is a balanced investment can help alleviate market fears and keep you on the right track for your long-term investment goals.

Paulina Likos is an investing reporter at U.S. News & World Report, covering investing and asset management. Before beginning her career as an investing reporter, Paulina graduated from Villanova University where she studied political science, communication and business management. Out of college, Paulina spent several years as a risk manager at Fannie Mae, predicting and reducing credit risk for the company.

You can follow and connect with Ms. Likos on LinkedIn, Twitter or send her a tip at [email protected]

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