Periods of extreme market volatility can leave investors wondering how to respond. Here is what you need to know!
In 2022, the S&P 500 index, which contains some of the most recognizable companies on Wall Street, suffered its worst half year in more than half a century [1]. The economic effects of COVID-19 lockdowns, Russia’s conflict in Ukraine and Federal Reserve interest rate increases all contributed to the slowdown.
So, what can investors do to give themselves the best chance to avoid a downturn in their own portfolios during times of uncertainty? Below are a few options investors might deploy when bracing for continued market turmoil.
Dollar-Cost Averaging
It’s important to understand that negative years on the stock market are typical during economic downturns because they are a natural component of the business cycle. One choice is to gain an advantage from dollar-cost averaging if you are a long-term investor (defined as having a time horizon of 10 years or more).
By buying shares at consistent intervals, you can end up purchasing shares at a low price when the market is down. If the strategy holds true, your cost will eventually “average down,” giving you a more advantageous overall entry price for your shares.
The application of long-term dollar-cost averaging in 401(k) plans is a common example of how to use the strategy.
Employees who participate in 401(k) plans can select the appropriate investments and the amount to contribute. Afterward, investments are made on autopilot each pay period. Employees may notice a greater or a smaller number of securities acquired in their accounts depending on the market activity at the relevant point in time.
Dividends [2]
Stocks providing dividend income have been durable in most U.S. recessions dating back to the 1940s, easing some of the pain that investors have felt as their portfolios have suffered a blow during the market downturns that tend to accompany recessions.
According to Ben Snider, a senior equity strategist at Goldman Sachs, dividends signal “that management teams have confidence in the business’s sustainability and that they will have the cash flows to pay the dividend.”
During the 12 U.S. recessions since World War II, the median decline in dividends paid by S&P 500 companies was only 1%. In five of those recessions, Snider claims there was no decline: 1949, 1974, 1980, 1981, and 1990. Goldman calculated these figures by comparing the four quarters preceding the beginning of each recession to the final four quarters.
Of course, recessions vary in length and cause. Consider the two-month economic recession from February to April 2020, when the pandemic caused much of the U.S. economy to temporarily shut down and GDP fell by one-third. That year, 42 S&P 500 companies suspended dividends, and 28 cut them. While many of the layoffs came from companies most affected by COVID-19 lockdowns, Snider notes that “2020 was particularly extraordinary in the speed with which the economy shut down and [corporate] cash flows slowed.”
However, he specified, “even in the sharpest and deepest recession in modern history, S&P 500 dividends only fell by 3%.”
Options [3]
There isn’t much incentive to take extraordinary risks in the hopes of making a fortune until the market’s future direction makes itself known.
Instead, try to capitalize on short-term volatility by incorporating options into your portfolio. The objective of this strategy is to allow the options market to compensate you for being a long-term stock investor.
Selling call options against shares of a stock can boost returns. The tactic, commonly referred to as “overwriting” or a “covered call,” is a basic component of the options market. Numerous people sell calls on the equities they own on any given day. There are a variety of methods to put the technique into practice, but most investors choose calls that are around 10% above the stock price with expiration dates ranging from 30 to 45 days.
The strategy compensates investors in exchange for agreeing to sell their stock at a higher price. If the stock price stays below the strike price, investors keep the call premium. Additionally, investors are not required to sell their shares if the price of the stock rises above strike price; instead, they can “roll” the position out for a month or more to avoid assignment. When done correctly, an investor is compensated for rolling the call.
Want to Know More?
While fears of a recession continue to lurk in the background, opportunities may reveal themselves, potentially presenting opportunities for growth. Are you hesitant about how to approach today’s market conditions? A financial advisor can provide information and clarity about opportunities and eligibility to invest in private equity.
