With the recent outbreak of the coronavirus in China, as well as the spread of the disease into a number of countries including the United States, there has been a spark of fear and panic. The markets have taken a downturn, creating some of the largest daily declines in two years. We have seen similar behavior back in 2003 with the SARS virus, and back in 2015/2016 with the Zika virus. Between these two viruses and the housing crisis of 2008-2009, we have seen major market declines within the past two decades. However, the market continues to run its cycle and has recovered under each of these circumstances.
As an investor, it is important to remind yourself to take a long-term approach with your 401(k) plan and think about the overall goals for retirement. With that in mind, here are a few things to consider when it comes to market volatility and investing in your 401(k) plan or IRA account.
Dollar Cost Averaging
When you’re contributing to your 401(k) plan, the amount you elect to contribute is being invested into your account every pay period (weekly, bi-weekly, etc.). When a consistent amount of money is invested in consistent intervals, this is a form of investing called dollar-cost averaging. With dollar-cost averaging, you are buying shares of a mutual fund throughout all different points in the market cycle. When the market is up, you are buying less shares at higher price. When the market is down, you are buying more shares at a lower price. The advantage to dollar cost averaging is that you are reducing timing risk, and in a fluctuating market, the average cost per share is going to be lower than the average price per share.
The Cycle of Emotion
The Cycle of Emotion addresses the emotional aspect of investing rather than the financial aspect. The stock market goes up and down, and your investment accounts will usually reflect that. People tend to get excited when they see the market go up and think that it’s a great time to buy into the market/invest more money. When the market goes down, many tend to panic, thinking that they are losing their money, and naturally feel obligated to sell their investments, at which point investors are officially locking in their gains or losses. Locking in a gain or a loss leads into the next point of understanding the difference between a realized gain/loss versus an unrealized gain/loss.
Realized vs. Unrealized Gains and Losses
When you see your account increasing or decreasing, you are not making or losing any money unless you sell out of your investment position, at which point you would notice a realized gain or loss. An unrealized gain or loss is when the value of your account is above or below the price at which you bought your investment and if you were to sell out of the position, what your return would be. For example, if you bought XYZ at $5/share and the value when down to $2/share, you would have an unrealized loss of $3/share. If, when that value went down to $2/share, you panicked and sold your shares of XYZ, you would now have locked in a realized loss of $3/share.
Stay the Course: Diversification and Long-Term Approach
While you are not able to control the markets, you are able to control the way your money is invested, as well as your approach and investment behavior. Through economic and market downturns, we encourage investors to remain diversified, take advantage of changing financial markets to reduce risk of loss, and focus on the long-term approach that aligns with your investment and retirement goals.