Investors: How to stop worrying and learn to embrace market volatility
Investment and Asset Management
The year 2020 saw extraordinary fluctuations in stock prices, including precipitous declines when COVID-19 first began spreading in the United States, followed by record highs. Although volatility can be unsettling, it has always played a part in financial markets. So, it’s important not only to accept volatility but to embrace the opportunities it can offer.
Have a plan and stick with it
A tumultuous market can be stressful, and it may be tempting to reduce your exposure to equities when stocks are riding a particularly scary roller coaster. Even though reallocating the contents of your portfolio may help you avoid some downside, it’s equally likely to cause you to miss out on stock surges. In the long run, this can damage performance even more than suffering stock slides.
Instead, learn to live with volatility by adopting a deliberate, long-term investment approach. There are no guarantees and it’s always possible to lose your initial investment. But history has shown that a well-diversified portfolio, with the appropriate mix of stocks and bonds, tends to perform well over the long term. This is despite periodic — and sometimes severe — declines.
Not only should you resist the temptation to sell stocks when the market’s unsettled, but you might also consider buying more of certain stocks when prices are low. This can help position you for future gains. Again, there’s solid historical evidence that investing during periods of steep market declines results in stronger long-term performance.
Adopt dollar-cost averaging
One way to adopt these strategies is to invest at regular intervals — regardless of what the market is doing — rather than invest only when you think the time is right. This systematic approach takes the emotion out of the equation and helps you resist the urge to participate in market timing.
Dollar-cost averaging is a systematic way to invest fixed amounts at regular intervals — for example, $1,000 per month in the same mutual fund or IRA portfolio. Contributing a portion of your paycheck to a 401(k) plan is another form of dollar-cost averaging. As prices fluctuate, investing the same dollar amount each time means that you buy more shares when prices are low and fewer shares when prices are high, thus reducing your average cost-per-share and taking advantage of price swings. Note that dollar-cost averaging doesn’t guarantee profits or protect against losses. Before signing up, you should consider your ability to continue making purchases through all periods.
You’ve probably carefully allocated your investment dollars among a mix of asset types based on your risk tolerance, investment objectives, and personal circumstances. However, your asset mix may get out of balance over time as certain assets outperform or underperform others. For this reason, you need to monitor your portfolio’s asset allocation and rebalance it when appropriate.
Just keep in mind that rebalancing doesn’t guarantee profits or protect against losses. And rebalancing can have tax consequences if, for instance, you sell appreciated assets and reinvest the proceeds. But market downturns can create opportunities to rebalance your portfolio at a lower tax cost.
Keys to managing risk
One other thing is essential if you’re going to ride out market storms: Maintain an emergency fund — particularly if you’re retired or approaching retirement. You don’t want to have to sell investments at a loss during a market downturn for living expenses. It’s far better to tap an emergency fund while giving your investments time to recover.
Indeed, the more time you have, the easier it can be to live with market volatility. Talk to your financial advisor about minimizing risk as you approach retirement or another goal. This may entail portfolio rebalancing and other strategies that make your holdings less vulnerable to the market’s inevitable ups and downs.