Whether you have an established investment strategy or are just getting started, chances are that you have already realized the markets are constantly fluctuating. The good news is that there’s a pattern to economic cycles—and understanding that pattern can help you make smarter, more strategic decisions about your portfolio.
Here’s everything you need to know about the four phases of the market and the core strategies that financial advisors everywhere use to weather the storm and capitalize on growth.
Understanding the Four Phases
One of the best things you can do for your investment strategy is to familiarize yourself with the way markets naturally behave. When you innately understand the natural rhythm of growth and decline, you have a far better chance of making decisions based on strategy rather than impulse.
Understanding each of the four phases of the cycle will allow you to make smarter investments.
Here’s a quickoverview of the four phases you should work with your advisor to recognize:
- Boom: During a boom, all economic growth trends upward at a growth rate of 4 percent or more for at least six months. Investors are enthusiastic about investing, even as inflation and prices rise.
- Peak: The peak marks the end of a boom phase, when the economy stops expanding, stock prices are less consistent, and interest rates rise as the Fed tries to curb inflation.
- Bust: The bust follows the peak and usually lasts less than one year. This phase is all about helping the economy reverse the boom, which often leads to higher unemployment and possibly a stock market crash. Recessions, which are longer lasting than typical busts, also occur here.
- Trough: Following a bust, the trough signals the bottoming out of the economy. At this phase, you will often find investors eager to make new strategic investments. Interest rates tend to drop, and the economy begins to stabilize, heralding a new boom phase.
The Danger of “Timing the Market”
Maybe you’ve heard of investors attempting to time the market to make above and beyond the standard stock market returns. After you learn these four phases, your first instinct might be to do the same: outsmart the process by selling stocks right before a contraction and then buying them back at the trough.
The problem? This is a huge gamble that rarely pans out for long-term investors.
Financial markets are forward-looking, meaning that stock prices will typically fall before the recession is officially declared. They will also begin to rebound before the economy shows tangible signs of improvement. If you have waited for the news to confirm an impending expansion, you have already missed the strongest days of the market recovery.
Instead, plan your long-term strategy around acceptance of the market’s variables. The idea that you can perfectly time these phases is nothing but an attractive myth, and impossible to achieve with regularity.
Core Strategies for Long-Term Resilience
Of course, there are some tried-and-true methods to make the most of ever-changing markets. These four core strategies will help you make wiser investment decisions.
Strategic Asset Allocation and Diversification
Chances are that your financial advisor has already cautioned you not to put all of your eggs in a single basket. The best way to weather economic downturns is to ensure your assets arespread across multiple buckets. From the stability of the U.S. Treasury bonds to dividend-paying stocks, it pays to have your portfolio well-balanced.
The right strategic asset allocation allows you to balance short- and long-term investments while keeping your finger on the pulse of the risk you are willing to endure as markets inevitably rise and fall.
Systematic Rebalancing
Sometimes, your portfolio will require some flexibility in the wake of short-term changes in the overall market. Some rebalancing strategies let you manage the frequency of rebalancing rather than sticking to a rigid schedule.
However, strategic rebalancing allows you to maintain some discipline in your investments. Your advisor may make regular adjustments on a timetable, eliminating some of the risk of attempting to time the market amid these short-term fluctuations.
Dollar-Cost Averaging
How much can you afford to invest going forward? Dollar-cost averaging allows you to invest a set amount of money on a regular schedule instead of saving and waiting for the “right” time to buy. You will automatically buy fewer shares when the prices are high during the peak phase. But you will also buy more shares when prices are low during a contraction or trough. This transforms a little bit of market volatility into an advantage.
Keep a Cash Bucket
Make sure you always have some cash on hand to draw on when markets are not doing as well. Financial experts advise keeping 6 to 12 months’ worth of expenses in an account you can readily access when you need them. With this emergency cash bucket in your back pocket, there is less chance that you will need to dip into your investments and sell them at a loss.
Establish Good Financial Habits Now with Magellan
Are you ready to stop attempting to time the market and instead make wiser money moves with your investment strategy? Magellan can help you create a detailed, personalized approach to your investments with an integrated team that covers financial, legal, and tax planning services.
Don’t leave your portfolio to chance.Schedule a consultation with our team to see how we can help you grow over the coming decades!
For a comprehensive review of your personal situation, always consult with a tax or legal advisor.
This material provided by Kevin Meaders was written by Axle Eight, a non-affiliate of Magellan Planning Group.