Tips for Retail Investors in the Face of Market Volatility
There’s been a flood of new retail investors into the stock market over the past few years. According to respected brokerage firm Charles Schwab, the COVID-19 pandemic in 2020 was the catalyst for many to open an account and begin tinkering with securities. As many as 15% of all retail brokers today have been invested for less than three years. And while there are more resources than ever before to help new investors get their bearings in the market, experience still remains the best teacher.
Nothing puts an investor’s mettle to the test like market volatility. You don’t truly learn your tolerance for risk until your portfolio begins to shed value amidst market downturn. It’s a situation many new investors are facing in 2022. The S&P 500 is rebounding from double-digit losses, yet is still down year-to-date. And there’s more turbulence on the horizon.
As new investors face uncertainty and volatility for the first time, it’s important to keep a few fundamental tips in mind. Here are a few of the most important lessons to remember.
1. Invest in What You Know
Many new retail investors decide to buy securities because they see potential for profit in a company. Unfortunately, they don’t always understand the fundamental business model or the industry. One of the oldest and wisest tips for any retail investor is to stick to what you know when first starting out as an investor.
Investing in what you know gives you the bearings to navigate in a market you’re familiar with. It might mean you have a keen understanding of hydrocarbon exploration or decades of experience as a wholesaler of consumer goods. Wherever your knowledge best-applies is where you should look for beginner investment opportunities. When you understand an industry, you’re better-equipped to make investment decisions with confidence.
2. Set Goals and Tolerances
The tendency of new investors is to open a position and wait for gains to begin rolling in. But what if your investment racks up losses first? What if it lags the market? What happens if it bounces up and down erratically? Without setting goals and determining your risk-reward tolerance, you’re prone to acting on impulse or emotion.
When opening a position, establish thresholds. “I will hold this stock for three years.” “I’m willing to lose 20% of principle before I consider selling.” “I believe this stock will deliver a 50% return on investment within one year.” Sketching out expectations for good and bad performance allows you to continuously evaluate investments and your actions as an investor. In setting goals and tolerances, you take emotion out of the equation.
3. Review Your Investment Thesis
Why are you investing in a company? Beyond its potential to generate a return on that investment, it’s important to understand your motivations for selecting specific securities. Does the company have an industry leading product? Disruptive technology or an innovative new business model? Exceptional leadership and a healthy balance sheet? No matter the reason, it needs to remain a viable one for the life of your position.
Beyond developing an investment thesis, investors need to continually evaluate that thesis. If something changes, it’s worth considering if your position should too. For instance, if you invest in a company because of its innovative new technology, but there’s no moat around that technology, it may not be long before competitors move into the space. If the company you’ve invested in can’t maintain its leadership, your investment thesis might change. Don’t be afraid to reevaluate your investment decisions.
4. Remember that Investments are “Unrealized”
One of the biggest mistakes new retail investors make is to look at their portfolio and make point-in-time judgements. They see shares of a company fall 30% and think they’ve lost 30% of their investment. This is only true if you exit the position. Remember that there are no gains or losses until you close a position and realize them. A 30% loss today might turn into a 30% gain in a few months, but only if you stay invested through the turbulence.
Similarly, it’s important to remember that the IRS also doesn’t consider gains or losses until you exit your investments. Many new investors are surprised to learn that they’ll owe the IRS by cashing out on well-performing short-term investments, yet they can avoid the tax bill by staying invested. Understand taxable events and how capital gains and losses impact you before realizing them.
5. Learn How to Evaluate Investments
Unless you have a background in finance or business, you’ll likely need to spend some time learning the nuances of corporate reporting. Get familiar with how to read financial documents and tune into company earnings calls when you can. Understanding how to evaluate the company from a fundamental standpoint goes a long way toward making informed investment decisions.
It’s also smart to get familiar with standard investment metrics. Learn valuation metrics like P/E and P/B, as well as free cash flow, debt-to-equity and beta. The ability to assess a company from multiple standpoints and through a variety of financial lenses can shed light on where a company excels, where it struggles and where there’s opportunity for improvement.
Retail Investor Experience is the Best Education
Aside from a substantial dip in 2020, the United States stock market has been in a bull market for more than a decade. For many retail investors, 2022 has been their first real taste of volatility that hasn’t come on the heels of a global black swan event. Now’s the time to fall back on fundamental tips like the ones above, to protect your investments from the market and yourself. Keep these in mind as you survey your own portfolio with a careful eye.