If you’re a little taken aback by the whipsaws in markets lately, you’re not alone. Though jarring, what we’re experiencing is a perfectly normal return to volatility following two years of unusually smooth sailing. The surprise was that markets ran ahead so far so fast without any appreciable pullback. Last year, we saw six of the seven lowest measures in volatility in history.
Keeping your cool can be hard to do when the market goes on one of its more traditional roller-coaster rides. It’s useful to have strategies in place that prepare you both financially and psychologically to handle market volatility. Here are a few things to keep in mind:
Have a game plan
Having predetermined guidelines that recognize the potential for turbulent times can help prevent emotion from dictating your decisions. For example, you might take a core-and-satellite approach, combining the use of buy-and-hold principles for the bulk of your portfolio with tactical investing based on a shorter-term market outlook. You also can use diversification to try to offset the risks of certain holdings with those of others.
Diversification may not ensure a profit or guarantee against a loss, but it can help you understand and balance your risk in advance. And if you’re an active investor, a trading discipline can help you stick to a long-term strategy. For example, you might determine in advance that you will take profits when a security or index rises by a certain percentage, and buy when it has fallen by a set percentage.
Know what you own and why you own it
When the market goes off the tracks, knowing why you originally made a specific investment can help you evaluate whether your reasons still hold, regardless of what the overall market is doing. Understanding how a specific holding fits in your portfolio also can help you consider whether a lower price might actually represent a buying opportunity.
And if you don’t understand why a security is in your portfolio, find out. That knowledge can be particularly important when the market goes south, especially if you’re considering replacing your current holding with another investment.
Remember that everything is relative
Most of the variance in the returns of different portfolios can generally be attributed to their asset allocations. If you’ve got a well-diversified portfolio that includes multiple asset classes, it could be useful to compare its overall performance to relevant benchmarks. If you find that your investments are performing in line with those benchmarks, that realization might help you feel better about your overall strategy.
Even a diversified portfolio is no guarantee that you won’t suffer losses, of course. But diversification means that just because the S&P 500 might have dropped 5% or 10% doesn’t necessarily mean your overall portfolio is down by the same amount.
Bottom line: Volatility is a reality of investing. If you’re investing long term, sometimes it helps to take a look back and see how far you’ve come. Give that a try. And when you do, remember that it’s the ups and downs of investing that help you make money. Though past performance is no guarantee of future returns, of course, the stock market’s long-term direction has historically been up. With stocks, it’s important to remember that having an investing strategy is only half the battle; the other half is being able to stick to it–even in choppy waters.
Remember that while they’re sound strategies, diversification, asset allocation, and dollar cost averaging can’t guarantee a profit or eliminate the possibility of loss. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.