Answering your questions about market volatility

Stocks sold off today, continuing their up and down ride to start the year. Azzad clients are usually savvy enough to know that these types of events are prime opportunities to rebalance their portfolios or to buy stocks while they’re selling at a discount. But even the best of us find ourselves questioning our financial plans every now and then. So, let the following answers to these frequently asked questions set your mind at ease:

Should I sell now?

Not unless you want to turn a paper loss into a real one. Try resisting the urge to sell by thinking about things this way: if you’re stuck in traffic, would you sell your car on the spot and buy a bicycle to get out of the jam? The thought might be tempting in the moment, but long term, you’ll probably regret that decision. It’s the same with markets.

Ride the market’s ups and downs, contribute regularly to your portfolio, and you could be rewarded for your patience.

Remember that when you own stock in a company, you own part of a business. The value of that business does not fluctuate as wildly on a day-to-day basis as its stock price. This means that its market price at one particular time may not accurately reflect what your ownership stake in the business is worth. When stock prices are affected by outside forces that can temporarily drive down prices, we have an opportunity to pick up quality companies at a bargain.

Why do I keep hearing on television that it might be time to rethink stocks?

Because you’re watching TV. First of all, turn off the television. We live in a 24/7 news cycle that preys on people’s worst fears. There’s no better way to lose your shirt in the markets than to follow the advice of some pundit or talking head.

The old saying in the news industry is that “if it bleeds, it leads.” In other words, scary attention-grabbing headlines sell newspapers and get ratings. But during times like these, try to remember the sage advice of legendary investor Warren Buffet who once said, “Buy when there’s blood in the streets.”

So what can I do?

First, make sure you’re properly allocated. Periodically, you should revisit your portfolio to make sure it’s aligned with your time horizon and financial goals.

By developing a balanced portfolio of investments, you make sure that not all your eggs are in one basket. This is known as asset allocation. A portfolio that mixes a variety of asset classes generally has a lower risk for a given level of return. Although it cannot guarantee a profit or protect against a possible loss, asset allocation, or diversification, can help spread the risk of investing because it broadens your investment base.

See: Diversification the Azzad Way (YouTube)

What’s up with all the volatility?

China and oil are the two most popular answers (more on those below). But there are other factors at work. For instance, take a look at big institutional investors like pension plans and mutual funds, which have pulled nearly $200 billion from the market since mid-2014, according to a January Wall Street Journal report.

So, who’s doing the buying and selling if the long-term “smart money” is on the sidelines? Answer: hedge funds, high-frequency traders, and exchange-traded funds that buy and sell rapidly, which can cause volatility.

But keep in mind that money parked in cash will eventually need to be deployed. That would be a boon for equities.

What’s the deal with China?

Emerging (developing) markets, of which China is the largest, account for 85% of the world’s population and 50% of global GDP. They have also been responsible for the lion’s share of global growth since the 2008 financial crisis, but capital has taken flight since not-so-great GDP reports and Fed tightening caused investors to sour on the Asian nation.

There’s no question that China is a big economy – the world’s second biggest, in fact. But according to Citigroup, U.S. exposure to China in terms of gross domestic product (GDP) is only about 0.7 percent of overall GDP.

And despite all the claims that we live in an interconnected world, China is actually pretty unplugged from the rest of the world’s economy. It isn’t very open to foreign investors, so it’s hard to imagine a spillover from stock market declines or debt default (if that ever happens). Although it is true that China’s economy is a major driver of global growth, much of the worry about China’s stock market these days is irrational. (Note the distinction between economy and stock market. They are not the same thing. The Chinese government has pushed its people to invest in stocks in the hopes of offsetting some of the pressure to provide a better social safety net for retirement. Lots of people borrowed cash to invest. That might not end well.)

One reason the subprime mortgage crisis spread far and wide was because of overseas exposure to losses on toxic U.S. assets. That simply can’t happen with Chinese stocks. It doesn’t mean that markets won’t sell off in sympathy with China, but investor sentiment is not a substitute for facts.

I thought cheap oil was good. Why do people see it as a cause for worry?

Cheap oil can be an indication that global demand is weak, and it can hurt oil and oil-related industries. Most analysts believe the sharp declines in oil prices have more to do with a supply glut than weakening demand. But the bottom line is that if you aren’t an oil company, an employee of an oil company, or a net oil-producing country, low oil prices aren’t necessarily a bad thing. For net importers like the U.S., lower crude prices means more money in the pockets of consumers. It’s like a huge tax cut or stimulus package — all without the need for congressional approval.

Should I be preparing for another 2008-style crash?

Probably not. Banking leverage has been reduced dramatically, going from a pre-crisis rate of 30 times equity (30:1 debt to equity ratio) to low double digits (and sometimes single digits) today. And, of course, banks are now barred from making risky investments with their clients’ money, which was another cause of the Financial Crisis.

Plus, businesses are only reluctantly expanding. And sub-prime mortgages are fleetingly rare these days. So, don’t count on a repeat of 2008.

These days, what’s more likely going on is an overreaction to financial news headlines and a willful ignorance of leading economic indicators in the U.S., which look pretty darn good. Moral of the story: turn off the TV and stick to your investing plan.

Past performance cannot guarantee future results. No investment strategy can eliminate the risk of losses. Asset allocation, dollar cost averaging, rebalancing and diversification are investment strategies used to help manage risk. They do not ensure a profit or protect against a loss.