How Can You Navigate Market Volatility?

Market volatility is the rate at which the market changes. Significant shifts can alarm investors of all experience levels.

Understanding how to navigate market volatility helps you manage your investments during periods of rapid change. The following tips can help.

Have an Investment Plan

You should be following a realistic investment plan that is customized to your:

• Investment goals

• Financial situation

• Time frame

• Available capital

• Risk tolerance

• Savings objectives

Following an investment plan for your short-term goals, such as purchasing a home next year, and long-term goals, such as retiring in 15 years, supports investment decisions based on educated reasoning rather than emotions. Using logic to make these decisions reduces the desire to chase current trends, increasing the risk of losing money.

If you lack an investment plan or would like professional guidance on the one you created, consider working with a licensed financial professional. Paying a licensed professional for assistance can cost significantly less than investing in something you do not understand.

If you are uncomfortable paying upfront for financial advice and services, there is a company that provides complimentary, confidential, customized financial plans and advice through its licensed professionals, and pays its representatives when they place individuals or families in programs that fit their goals and needs. Message me if you would like more information.

Determine Your Risk Tolerance

Investments such as stocks, bonds, and mutual funds carry risks. For instance, a stock’s price can substantially decline, a bond issuer can default, and cash investments can grow more slowly than inflation. As a result, you must determine your risk tolerance when selecting your investments.

The following characteristics impact your risk tolerance:

• Age: The younger you are, the more risk you might be willing to take. You have more time to make up losses.

• Risk capital: For instance, if you are single, you might want to take on more risk than if you are the primary earner for your family.

• Net worth: The bigger your investment pool, the more willing you might be to take on risk. Ensure you can manage comfortably, despite any significant losses.

• Time frame: Markets are subject to short-term fluctuations. Therefore, if you invest money you plan to use soon, you might have to sell when the market is down, losing money.

• Timeline: As you near retirement, you should move at least some of your investments out of volatile stocks and/or stock funds into income-producing bonds and/or bond funds. Consider leaving some investments in equities with growth potential in case you live longer than expected.

Be mindful that actively avoiding risk is risky. For instance, keeping your money under your mattress will not grow your balance beyond the amount you save. Because inflation increases the prices for goods and services, a lack of investment reduces your purchasing power over time. As a result, you should invest some of your money for short- and long-term growth.

Avoid Trying to Time the Market

Stay invested in the market, even during turbulent times:

• Trying to time the market typically leads to missing out on significant returns.

• Selling at or near the bottom of the market and buying after it appreciates damages your portfolio. 

• Choosing an active, passive, or combination investment strategy and letting it work for you is more effective.

Invest at Regular Intervals

Because market behavior is difficult to predict, dollar-cost averaging takes the guesswork out of when and how much to invest:

• Dollar-cost averaging involves purchasing a fixed dollar amount at regular intervals over time.

• This long-term strategy reduces your exposure to the risks of making a large investment at the wrong time.

• While the dollar amount of each investment remains constant, the number of shares purchased depends on the share price at the time of a purchase.

• When the markets are up, you purchase fewer shares; when they are down, you purchase more.

• Regular investments over many years help your portfolio recover from short-term downturns.

Diversify Your Portfolio

Diversification involves investing in a variety of securities that react differently to the same economic factors. If one security underperforms, others might perform better, offsetting any losses. 

The three main asset classes to focus on when diversifying your portfolio are stocks, bonds, and cash equivalents. Each asset class has a level of risk and return. For instance, whereas equities typically offer the highest risk and return, U.S. Treasury bills have low risk and low returns.

You can further diversify your portfolio by allocating your investments to different subclasses:

• Market capitalization: You can choose stocks from small, mid-sized, and large companies.

• Economic sectors: You might select securities issued by companies across industries such as technology, health care, and utilities.

• Fixed income: You could choose fixed-income securities from different issuers, such as corporations or the U.S. government.

Use the following to determine your asset mix:

• Your investment objectives

• Time horizon

• Available capital

• Risk tolerance

Consider purchasing shares of a mutual fund for a readily available source of diversification:

• A mutual fund pools investors’ money to purchase a variety of securities such as stocks and bonds.

• You own a share of the underlying securities.

• Your investment is spread across companies, sectors, and geographic regions.

• If one asset performs poorly, others might perform well, helping to smooth out volatility.

Let Compounding Work for You

Compounding is the process by which an asset generates earnings through the initial principal and accumulated earnings. This process lets you earn interest on your principal and interest.

The future value of an investment depends on three main variables:

1. Dollar amount contributed

2. Rate of return earned

3. Length of time of savings

Although increasing any of the three variables can increase the future investment value, time is the most important variable. The longer money is invested, the more compounding can potentially grow the asset.

Start investing now to take advantage of compounding. You could reach your financial goals faster than expected.

Avoid Dwelling on Short-Term Performance

You might want to act quickly during market volatility, through panic selling or euphoric buying. However, impulsive trading is typically detrimental to your long-term results.

Remember, you purchased an investment because of its growth potential:

• If a company has strong business fundamentals, short-term price fluctuations should not affect its long-term value.

• Short-term volatility can present a time to purchase additional stock if you believe in the company.

Have an exit strategy if a company’s stock reaches your predetermined target price or the fundamentals take an adverse turn. Take time to determine whether the downturn is short-term or a permanent risk to your capital before selling an investment.

*This information is for educational purposes only.

Let me know in the comments which personal finance topic I should write about next!