How to navigate market volatility
Market volatility is a natural part of investing, but it can be scary for even the most seasoned investors. Sudden swings in the market can trigger fear and uncertainty, leading to knee-jerk reactions that may harm your long-term investment goals. However, by employing effective strategies for navigating this turbulence, you can protect your portfolio and even capitalize on opportunities that arise during uncertain times. In this article, we'll explore some strategies for handling market fluctuations and maintaining financial stability in an ever-changing investment landscape.
Diversify your investments
Diversification is key to mitigating the impact of market volatility. Instead of putting all your eggs in one basket, spread them across various asset classes, sectors, and geographic regions. By doing this, you can reduce the overall risk of your portfolio. If one sector takes a hit, you've still got other areas where there may be potential returns. Diversification helps ensure that a downturn in one area of the market won't have a catastrophic impact on your entire investment portfolio.
There are plenty of ways to diversify your portfolio, but here are some of the different areas your portfolio can dip into.
Stocks: Stocks represent ownership in companies and can offer high growth potential but also carry higher risk.
Bonds: Bonds represent loans to governments or corporations and generally offer lower risk and returns compared to stocks.
Cash equivalents: These include money market accounts and certificates of deposit (CDs) and offer low risk and low returns but provide easy access to your cash.
Real estate: Real estate can be included through Real Estate Investment Trusts (REITs) and offers potential for diversification and inflation protection, but may be less liquid than stocks and bonds.
For a deeper analysis on each of these different investment opportunities, check out our ultimate guide to investing.
Adopt dollar-cost averaging
Instead of trying to time the market perfectly, adopt a strategy of dollar-cost averaging. Dollar-cost averaging is a strategy that involves investing a fixed amount of money at regular intervals, regardless of market conditions. By consistently investing over time, you can take advantage of market downturns by purchasing assets at lower prices. This strategy helps smooth out the highs and lows of the market and can result in better long-term returns. While this may seem confusing at first, there are plenty of resources out there like Charles Schwab that can help. Let’s walk through an example as well. Let's say you decide to invest $100 in a particular stock every month for 6 months, regardless of its price. Here's how your investment might look over time, assuming the stock's price fluctuates:
Month 1: Stock price is $10, so you purchase 10 shares ($100/$10).
Month 2: Stock price drops to $8, so you purchase 12.5 shares ($100/$8).
Month 3: Stock price rises to $12, so you purchase 8.33 shares ($100/$12).
Month 4: Stock price falls to $9, so you purchase 11.11 shares ($100/$9).
Month 5: Stock price increases to $15, so you purchase 6.67 shares ($100/$15).
Month 6: Stock price drops to $7, so you purchase 14.29 shares ($100/$7).
At the end of the 6 months, you would have invested a total of $600 ($100 each month). However, due to the varying stock prices, you would own a total of 63.2 shares.
By consistently investing over time, regardless of market conditions, you were able to take advantage of lower prices during market downturns and accumulate more shares. This helps to reduce the impact of market volatility on your overall investment and potentially leads to better long-term returns.
Take a long-term perspective
Think of investing as a marathon, not a sprint. Despite the ups and downs, historical data, like this chart, shows that the market has always bounced back and trended upwards over time. For example, consider the case of an investor who remained steadfast during the 2008 financial crisis. While the short-term fluctuations may have been unsettling, those who maintained a long-term perspective and stayed invested saw their portfolios recover and even thrive as the market rebounded in the subsequent years. Make sure you have a long-term perspective and avoid making impulsive decisions based on short-term fluctuations. By staying focused on your long-term investment goals and avoiding reactionary behavior, you can navigate market volatility with confidence.
Prioritize quality over quantity
During periods of market volatility, focus on quality when picking investments. Consider the example of an investor who carefully scrutinizes companies' fundamentals before making investment decisions. By focusing on companies with strong financial health – such as consistent earnings growth, low debt levels, and a competitive edge in their industry – this investor ensures that their portfolio is resilient in the face of market turbulence. For instance, amidst the uncertainty of the COVID-19 pandemic, companies with robust balance sheets and sustainable business models proved to be more resilient, weathering the storm and eventually rebounding. You can do this by looking at a company's past financial records or staying informed about the latest news that involves the company. Both approaches provide valuable insights into the company's prospects and its ability to navigate market volatility effectively. By prioritizing quality investments, you can position yourself for long-term success and minimize the impact of market fluctuations on your portfolio.
Stay informed, but avoid overreacting
In the age of information overload, it's easy to get swept up in the latest market buzz. Stick to trusted financial sources, filter out the noise, and stay focused on your game plan. Take, for instance, an investor who follows financial news from reputable sources and filters out irrelevant noise. By staying informed without getting swept up in the market buzz, this investor maintains a clear focus on their investment strategy and avoids being swayed by short-term market fluctuations. Amidst market volatility, keeping a level head is important. Consider the example of an investor who remains calm and composed during a sudden market downturn, refraining from making impulsive decisions. By adhering to their long-term game plan and resisting the urge to react hastily, this investor safeguards their portfolio from unnecessary risk and potential losses.
Utilize stop-loss orders (with a twist)
Stop-loss orders can be an effective tool for managing risk during periods of market volatility. These orders automatically sell a security when it hits a predetermined price, preventing you from taking on too much risk. Opt for trailing stop-loss orders during volatile times. These orders adjust upward as the security price increases, allowing you to ride the waves of gains while still protecting against sudden downturns.
These orders automatically sell a security when it reaches a predetermined price, helping to limit potential losses. However, it's important to consider a trailing stop-loss order instead of a static stop-loss order during volatile times. A trailing stop-loss order automatically adjusts the stop price upwards as the security price increases, allowing you to capture some of the gains while still protecting yourself from significant downturns. Investopedia provides a great explanation of trailing stop-loss orders.
At Motion, we understand that navigating market volatility can be challenging, but it doesn't have to derail your investment strategy. Our platform provides the tools and resources you need to help you with every step of your money management journey and provides guidance to help you achieve your financial goals. Whether you're a personal finance expert or just getting started, Motion has your back. Sign up today and take control of your financial future!
