Market volatility can throw you for a loop, but trusting the long-term nature of your plan will probably keep you on track. Learn three new ways to deal with that rollercoaster ride, and some smart steps to take when the market moves.
One way of limiting short-term volatility in markets is through dollar cost averaging, whereby you set up regular investments (say, quarterly or even monthly), committing yourself to buy a set amount regardless of what the market shows at the time. You can mitigate the risks of missing out on the crest of the wave by deliberately missing the crest, so to speak.
Diversification
Diversification became a default method to smooth volatility, by spreading one’s bets across asset classes, industries and geographies, so that an outflow in one area doesn’t amplify relative returns everywhere else too much.
Diversification can take place at two levels – from a macro view, diversify across large, mid and small cap stocks; from a micro view, within an industry – invest in railroad stocks if an increase in consumer travel threatens a decline in airline stocks.
Diversification alone is not enough, and bringing it into balance has always required constant monitoring of market signals and economic indicators to rebalance a portfolio – as is done with individual stocks, typically every three months by CalPERS, for example – capture the upside in good bull markets and mitigate risk and volatility over the investment cycle; this approach, called core-satellite, continues to hold up over time.
Focus on Long-Term Goals
Another mistake so many investors make during times of market volatility is to let their emotions drive their investment decisions – impulse buys during an upswing and panic sales after a downturn. Thinking through your long-term investment plan and how asset allocation supports that plan should help you be more disciplined, less irrational in your emotional responses, and make better decisions. Regular investing strategies such as dollar-cost averaging may also help to mitigate risk associated with timing the market by buying high or selling low.
If you do decide to include unpredictable stocks, initiate the process with some cold, hard research into the companies’ business model, financial results and competitive advantages; know where you’re going with your investments, both in terms of your long-term portfolio goals and your risk tolerance; and (if you haven’t already) find a financial professional to independently assess your portfolio and provide recommendations, based on your particular situation and needs, that meet your criteria. Furthermore, you should familiarise yourself with the norms that surround volatility, so that you’ll know what to expect and how best to react when it comes to prospective stocks, mutual funds or exchange-traded funds whose prices tend to fluctuate more.
Practice Dollar-Cost Averaging
This strategy involves investing a regular amount set in advance at regular intervals, whether prices are low or high, so that you buy more units when prices are low and fewer when prices rise – thereby helping to reduce the total costs of long-term investment.
And research has found that even professional money managers lose substantially from ‘high-emotion trading the day after a very dramatic trading day. This is when people go and trade based on feelings – because you feel like a hero or you feel like a loser, and you’re trading based on your own emotion.’
And if you’re itching to put your money to work in investments with high degrees of volatility, you’d be well served to consult with a financial professional about your objectives, your personal risk tolerance and time horizon, as well as your financial circumstances. They can help arrive at an appropriate investment plan for you that fits well in times like these – perhaps one that allows short-term market declines to wash away companies whose valuations are artificially enhanced by greed and fear, but doesn’t put companies with durable earnings power and/or competitive advantages at risk of more than simply a short suspension of supply and demand calculations.
Maintain a Cash Reserve
There’s a good chance you’ll find it more unnerving to watch your portfolio’s value go up and down through the years, but so be it – it’s part of investing. Understanding the historical context of market downturns, and learning how to prepare yourself for the unavoidable next one, is part of the process that can help you maintain an appropriate investment strategy and continue towards your long-term financial goals.
Having a cash cushion can be a good way to protect against markets swings. By stashing some money in tax-deferred or tax-free accounts – essentially savings accounts within IRAs and 401(k)s – you’ll be freezing the money and avoiding skewing your portfolio with gains or losses when markets fall.
An unstable market is a good opportunity to see how well your current asset allocation performs. A Morgan Stanley advisor can review your investment portfolio using our Goals Planning System and other tools, and then make recommendations that might help reposition your assets so you stay on track with your goals.
