Investors don't need to look beyond the investing industry itself to know that all is not well in the markets — and it hasn't been for some time already.
After reaching the $600 mark per share earlier in 2018, BlackRock, the investment and ETF giant, has seen its stock price drop by more than 20 percent year-to-date. While its ETF business has remained strong, $24 billion in investor money came out of BlackRock's index funds in the third quarter, part of the $100 billion in outflows from equity mutual funds.
The roughly $200 billion in ETF flows so far this year is significant for the industry for a not-so-good reason: It is less than half of last year's record $476 billion and below 2016's $287 billion. With flows in the past month of less than $3 billion, 2018 is looking like the first year in a while that the ETF industry won't set a new record.
"The biggest concern I see is that we may be at peak earnings," Laurence Fink, BlackRock's founder and CEO, recently told CNBC. "We definitely see anxiety. ... The markets are showing that, that investors are confused."
Fink went on to explain that the outflows were "very explainable by some large derisking" in hedge funds.
Goldman Sachs' new CEO, David Solomon, recently told CNBC some of the October selling "is the result of programmatic selling because as volatility goes up, some of these algorithms force people to sell."
If derisking and programmatic selling aren't enough to calm your nerves — and these explanations should not be enough — what is an individual investor to do when both the S&P and Dow are on the verge of going negative on the year (both were on Wednesday), and the only question worth asking seems to be "Should I go to cash?"
The answer to that question is not a "no," but rather to remind investors that that question is about as helpful as derisking and programmatic selling explanations for market tumult. Individual investors saving for retirement at all ages are being tested by the recent volatility in the market, but what's being tested is not their ability to know the exact right moment to get out — the market was rebounding on Thursday, for what that is worth (not much). What is really being tested is more fundamental — whether an investor has a plan in place at all.
1. Being prepared for inevitable volatility is a must.
For anyone who pays attention to the markets on a regular basis, "It's February all over again" should sound right — at least as a starting point. February 2018 was a month of significant stock market volatility with all the major equity indexes down by significant percentages.
"It is February all over again," said Mike Loewengart, chief investment officer at E-Trade Capital Management. "We have seen this before; we lived through this eight months ago and we know how that worked out — went to new highs. It was pretty violent and it wasn't fun, but thing I point out to clients is that this type of volatility is normal. This is what the pre-financial crisis markets were like and no one ever assigned an extraordinary label to it."
The placid conditions that dominated throughout 2017, and in the third quarter this year after the February bout of jitters, are not the historical norm. In the third quarter, there was not a single market day when the S&P 500 rose or fell by more than 1 percent. The CBOE Volatility Index dropped more than 19 percent, its biggest quarterly decline since the first quarter of 2016.
The current volatility is like February, but worse. The Dow Jones Industrial Average ended last week with its first weekly gain in a month, but the volatility has picked right back up. The Dow and S&P 500 went negative on the year on Wednesday, and by Friday, the S&P 500 had entered a correction. It marked the second 10-percent decline for the S&P this year, an unusual occurrence, and it happened over one of the shortest time spans in market history (six weeks) since 1928. The Nasdaq is down 9 percent this month.
Being prepared for inevitable volatility is a must.
2. What is being tested are your emotions and endurance.
For all the ink spilled over what has made Berkshire Hathaway chairman and CEO Warren Buffett such a phenomenal investor, it is pretty simple — he has always endured as an investor, meaning, he doesn't jump in and out of the market.
Buffett once remarked that at times of big swings in the market is is wise to remember that the stock market is there to serve you, not instruct you. It can only serve investors if they accept two fundamental truths — one about themselves and one about making money in stocks.
Investors are often reminded to not make emotional decisions. That's bad advice. Investors need to accept that they will never master their emotions, and the only way to control them is to have a plan, and to make endurance a big part of it. This was stated pretty well in a recent blog post from Morgan Housel of the Collaborative Fund.
"It's wrong – dangerous – to assume that because you have a long time horizon you can ignore the short run. If you ignore something, you're unprepared for it. And when you're unprepared for it it will eventually take advantage of you. The beauty of a long time horizon is capturing a compounding effect that others who quit before you forgo. But that only works when you're keenly aware of, and prepared for, and managing for, the kind of short-term stuff that people with shorter time horizons don't want to deal with. Having the endurance to make long time horizons work means your allocation, cash flow, and mindset are intentionally designed to deal with the nonsense that occurs within short time horizons."
3. Buy and hold isn't always so easy — is there such as things as buy and hold-plus?
That's the question that financial advisor Douglas Boneparth posed to me trying to make sense of the recent market jitters.
"Buy and hold is hard," Boneparth, founder of Bone Fide Wealth and a member of the CNBC Digital Financial Advisor Council. "People thought it had gotten to be easy given the last eight years. Do nothing, stick to the strategy."
Telling investors to "do nothing" does work over the long-term, but might not be enough at times when volatility surges, Boneparth recommends thinking in terms of a buy and hold-plus concept. "Anyone can do it."
A broad-based asset allocation, adjusted for an individual's risk tolerance and time horizon, can be applied to a 401(k) or a brokerage account, and it allows any investor to remain disciplined, stick to the model, and implement a strategy of looking for opportunities over time.
A survey done at the beginning of October by E-Trade of self-directed investors with $1 million or more in a market account and provided to CNBC — conducted before the biggest swings in the market but during a period of time when the S&P was down by 1.6 percent — found that even with the fourth quarter off to a negative start, the largest group of investors (43 percent) had no plans to make changes to their allocations. Fewer planned to go to cash — 12 percent of investors with at least $1 million in a brokerage account planned to move out of current positions and into cash, down from 15 percent in the third quarter. However, an increasing percentage of millionaire investors did plan on making changes to their allocations, up from 28 percent to 39 percent in Q4.
"To me, the number that stands out is that more investors plan to make no changes at all," Loewengart said.
4. Start with the facts — it does look like a peak.
The E-Trade survey found a high degree of confidence in the U.S. economy, but also a growing belief that the economy has reached its peak. Forty-nine percent of millionaire investors described "economic growth as reaching its maximum limit," the first time the quarterly survey has asked that question.
"No one is heading for the hills, but expectations are being tempered as far as economic cycles go. One won't persist forever," E-Trade's Loewengart said.
Paul West, managing partner and lead advisor for Carson Wealth, which works with many affluent investors, said he is not giving clients guidance that "sunny skies" are on the horizon: "We have moved from partly sunny to partly cloudy, not a full storm, but more clouds than before as we look at it."
There are three reasons for this view which knowledgeable investors should already have on their radar
Rates are one factor, but not the rise in the benchmark interest rate in and of itself — it's the sticker shock homebuyers will see with mortgage rates above 5 percent, West said. "We think people will have a hard time once they go apply for a 30-year mortgage and see it above 5 percent. People have not seen that and it will be a psychological barrier."
"In the past week I had more clients and people calling and inquiring about current cash rates than we've had in nine years."
Market valuations after a 10-year bull market are another factor. There has not been a 20 percent decline in a decade and that usually occurs once every four years, West said. "The reality of where we are in the cycle and where valuations are, we are in a high danger zone."
The third factor is the slowdown in China, which can have a spillover effect on the global economy, and is an issue of high visibility for the market.
"Today there are lots more yellow and orange indicators. More things suggest we are at a top," Boneparth said. "You put these facts out there and hope people make smart decisions, and generally, the smart decision is to put yourself in a position to not let emotions drive decisions. Whatever recession walls you build will be under siege; the ones that crumble are built by those who allow emotions to take over."
5. Be opportunistic, but don't be all-or-nothing.
"Whatever later inning of the cycle you think we are in, we are in later innings," Boneparth said. But discipline requires still very much participating in the market, he said. The smart decision could mean dialing down equity exposure from 100 percent to 80 percent for younger investors, and investing in a variety of more conservative assets, from bonds to money market accounts, and cash. For older investors, dialing down equity exposure from 70 percent to 60 percent, for example, shouldn't be seen as a permanent change, Boneparth said, but as a future opportunity to increase equity exposure at a later date if the market does decline significantly.
Many investors started this fourth quarter believing the market would continue to rise. And given weakness in the tech sector in Q3, the millionaire investors surveyed by E-Trade saw tech stocks as being the best sector opportunity in the market — 57 percent cited tech as the sector with the most potential in Q4, up from 35 percent who thought so in Q3.
But it is hard to know whether even these investors' emotions may have taken a toll since the survey period ended on Oct. 9, especially as tech continues to get pummeled, or will see the beating in tech as the perfect opportunity to reinvest. The Nasdaq is experiencing its worst month since November 2008.
Carson Wealth's West said even though he thinks stock multiples within the S&P 500 are high, some tech multiples are still justifiable. "The valuation is astronomical but we've never been in a world where tech is as dominant as it is today."
West said that the volatility has not yet led investors to take risk off the table from stocks to get three percent-yielding bonds, however, he added, "In the past week I had more clients and people calling and inquiring about current cash rates than we've had in nine years. It is moving up peoples' thought process," West said. "We haven't heard people talk about cash in a long time, ask what does a current money market pay and how to get the best money market."
There are multiple ways to be opportunistic, from ETFs that are designed to be more defensive to dialing back the equity risk and pursuing cash or cash equivalents.
"We are seeing lots of interest in money markets, too," E-Trade's Loewengart said. "Everyone forgets a 4 percent yield in money markets pre-crisis was normal."
West said investors need to know "that it is OK to take some chips off table" after a decade of gains. But this needs to be done in a way that offers downside protection rather than completely missing out on market returns. His firm prefers to buy puts as a way to manage risk. If the market keeps going up, then an investor has a small headwind related to the put, and a cost, but it protects them from any larger downside. West said using puts takes out some of the bigger challenges of trying to predict where the market will go, such as interest rates and long-term bonds. But investors need to understand that by taking chips off table they can lose a little return. "We were down a little over 3 percent in 2008, so we didn't have to climb out of that gigantic hole people fell down."
Mitch Goldberg, president of investment advisory firm ClientFirst Strategy, said for most investors 45-years-old or younger, a discussion about cash is not even one to have. And even for older investors, "you can't be out of stocks 100 percent. That is not what being an investor is all about."
There are reams of long-term data on how investors who get out of the market to avoid a correction wait far too long to get back in, and miss out on entire bull markets. As is often said as a warning about how hard it is to time markets, "going to cash" means an investor has to be right twice — both when to get out and when to get back in.
Goldberg is concerned about conditions for investors who are in their 50s and more so, in their 60s or older, and for many he is moving between 20 percent and 30 percent into a Vanguard money market fund (VMMX), which has an expense ratio of 0.16 percent and pays 2 percent.
For any investor who finds themselves asking, "Should I go to cash?" but without asking that question within the framework of a larger asset allocation and investing plan, the most likely long-term outcome isn't safety, but failure.
"How many times have we broken the market and how many times have we fixed it," Boneparth said. "The right thing is to have a strategy and discipline, or do whatever you can to make sure you do."
E-Trade survey was conducted Oct. 1–Oct. 9 among an online U.S. sample of 956 self-directed active investors who manage at least $10,000 in an online brokerage account, including 134 investors with at least $1 million whose responses are provided exclusively to CNBC.