If you are going to be an investor, then you have to get used to the idea of market volatility. There’s simply no way around it.
What exactly is market volatility? Investopedia.com defines it this way: “a statistical measure of the dispersion of returns for a given security or market index.” Volatility is typically characterized by wide fluctuations in security prices and heavy securities trading volume.
Uncertainty Leads to Volatility
Market volatility is caused by uncertainty, which is inherent in investing. Unless you park your cash in low-yielding money-market funds or Treasury bills, there will always be some uncertainty when you invest.
Of course, the degree of uncertainty — and hence, market volatility — changes over time. For example, the first year of a new Presidential administration is usually a time of higher uncertainty and more volatility as investors absorb what the new leadership is going to mean for the economy and markets. So far this year, the markets have risen sharply due to investor optimism about President Trump — but this could just as quickly change should negative economic indicators or sentiments arise.
Momentum can swing market volatility on both the upside and the downside. The recent rise in the stock market due to optimism about the Trump administration is a good example of upside momentum. On the flip side, algorithms can trigger computerized selling that quickly shifts momentum to the downside.
One of the best examples of momentum carrying the markets higher was during the dot-com bubble of the 1990s. In 1996, former Federal Reserve Chairman Alan Greenspan coined the term “irrational exuberance” to describe what was happening in the markets at that time. Unfortunately, this same momentum soon kicked in to send the markets in the opposite direction when it became apparent that highly valued Internet startups had no chance of earning any real profits anytime soon.
The “herd mentality” can also contribute to upside or downside momentum and market volatility. This occurs when it appears that everyone else is either buying or selling securities. Investors either fear missing out on big gains, so they pile into the market so they aren’t left behind. Or they fear suffering huge losses, so they pull out of the market to limit their losses. Both reactions lead to emotional investing, which increased market volatility.
Managing Market Volatility
While market volatility can’t be eliminated, it can be managed. Here are 5 strategies for reducing the impact of market volatility on your portfolio:
- Remember why you own your investments. This goes back to having an overall investment plan. Your plan isn’t based on market forecasts or expectations, but on your investing goals — which are different from everyone else’s. When you understand why you own a security, you’re less likely to make emotional decisions that increase volatility in your portfolio.
- Invest regularly despite volatility. The best way to do this is to practice dollar-cost averaging. Here, you invest the same amount of money every month, regardless of market conditions. As a result, you tend to even out the price you pay for securities over time, thus reducing the impact of market volatility.
- Don’t try to time the markets. This is one of the biggest mistakes investors make: trying to guess when the markets will go up or down make buy and sell decisions accordingly. Consistently timing the markets with any degree of accuracy is almost impossible. Remember: time in the markets is better than trying to time the markets.
- Take a long-term view of investing. This goes back to your investment plan, which should be focused on long-term investing goals. Investing is a marathon, not a sprint, and making emotional decisions based on short-term market volatility are usually a recipe for failure.
- Make sure your portfolio is well diversified. Your portfolio should include the right mix of equities, fixed-income and cash equivalent investments based on your goals and risk tolerance. By ensuring proper diversification of securities among these primary investment classes, you will help reduce the impact of market volatility on your portfolio.
A Disciplined Investing Approach
ACG can help you avoid the negative impacts of market volatility on your portfolio, starting with helping you create an overall investment plan. In addition, we will help you follow and stick to a disciplined approach to investing, no matter how volatile the markets are. To learn more, please give us a call.