For many investors, anxiety can shoot through the roof when swings in the stock market occur. No one knows if declines will be prolonged or when the highs may come crashing down. Uncertainty can make investing and weathering the storms a daunting task. The truth is, however, that volatility is a historically common occurrence and an aspect of investing that must be accepted in order to be successful. In today’s article, I’ll cover the basics of market volatility, why it matters, and provide three tips to manage it.
The Basics of Market Volatility
According to Investopedia, “volatility is a statistical measure of the dispersion of returns for a given security or market index.” In essence, it describes the degree to which a stock (or market index) price fluctuates either up or down. Typically, there’s a direct correlation between the level of volatility and the level of risk assumed in purchasing a particular stock. In other words, the higher the volatility of a particular stock or market index, the riskier it is to own it.
You can track general market volatility through the Volatility Index (VIX), which is an index the Chicago Board Options Exchange (CBOE) created to gauge the 30-day expected volatility of the U.S. stock market. If the VIX reading is high, it signals investors are bearish and implies it’s a risky market to jump into. If the VIX reading is low, on the other hand, it signals investor sentiment is bullish and the market is less risky to buy into.
For gauging the volatility of individual securities, investors use a measurement called “beta”. Beta effectively compares the overall volatility of a particular stock’s returns against the returns of a relevant benchmark. If a stock has a beta value of 1, it means the stock moves in line with the benchmark. If it is above 1, it moves more than the underlying benchmark (more volatile) and if it’s less than 1, it moves less (less volatile).
Why Market Volatility Matters
Let’s face it, the stock market is unpredictable ー it can drastically change from one day to the next and we can’t control in which direction it heads. We do know, however, that over the course of history, the stock market has gone up and long-term investors have been rewarded for remaining invested.
Understanding this concept is extremely important to making the right decisions when it comes to the inevitable market volatility we’re bound to see from time to time. Fortunately, no drastic measures need to be taken to successfully handle market volatility over the long-term. You just need to take control of tof what you CAN control.
3 Tips to Manage Market Volatility
1. Stay focused on your goals
With so much noise and negativity in the media, it’s easy to lose sight of your goals and make the wrong decisions. You need to remind yourself of why you’re investing in the first place. Is it for retirement? Is it for your kids’ education? What are you trying to accomplish?
As long as your investment portfolio allocated correctly to make progress towards goals, then it doesn’t matter what the stock market does from day to day. The only thing you need to worry about is staying the course. History shows the economy goes through natural fluctuations of growth and recession. We can’t change that. Bear markets and volatility will exist, so it’s important to keep the bigger picture in mind.
2. Stay diversified
Diversification is one of the most powerful tools for managing market volatility. You’ve certainly heard the saying “don’t put all your eggs in one basket.” This is the very essence of diversification. If all your eggs are in one basket and you drop the basket, then you have no more eggs. If you put multiple eggs in multiple baskets, however, even if you drop several baskets, not all your eggs are broken.
Diversification serves other purposes as well. It can help reduce overall risk, lower volatility, and enhance overall returns. In the graph below, we have a 20-year snapshot from 1998 to 2017 where you can see the benefits of a diversified portfolio (orange). In most years, the diversified portfolio provided steadier (less volatile) returns than individual asset classes. The graph also shows how it’s impossible to predict which asset class will be the highest performing in any given year. As a result, the key to weathering market volatility and being successful long-term is diversification.
[Source: Blackrock: Asset Class Returns]
3. Stay invested
Watching the ups and downs of market volatility can be stressful and anxiety-ridden. It’s easy to face desires to sell when the market tanks. However, selling in down markets is the least logical thing to do, as it typically only results in losing money. Yet, it’s still one of the biggest hurdles many investors face to being successful long-term despite the fact that the stock market has historically gone up over time.
To prove this point, in the S&P 500 historical chart below, you can clearly see fluctuations through the S&P 500’s entire history. You can also see the times when all hell broke loose and investors thought Armageddon had finally arrived (e.g. 1930’s Great Depression, Recession of 2007). Yet, despite all the crazy chaos and newsworthy market dips, the overall end result has always been an increase in value. Even through the worst of markets, those who’ve stayed invested have ultimately been rewarded.
The Bottom Line
Unfortunately, market volatility will always remain unpredictable and uncontrollable for investors, but that’s ok. We don’t need to control what the market does to be successful investors, we only need to control how we react to it. Your long-term plan should be to stay focused on your goals, stay globally diversified, and stay invested even in down markets. Implementing these tips will help you be successful investing regardless of which direction the market heads in on any given day.
If you’ve had a hard time stomaching market volatility or need help designing a portfolio based on your goals, schedule a free consultation with us today.
Chad Rixse grew up in Anchorage, Alaska and lived in Seattle, WA for 11 years where he graduated from the University of Washington before moving back to Alaska. He is fluent in Spanish, loves to travel and connect with other cultures. He’s been helping clients plan for their financial futures since 2014 and has an immense passion for helping others and making a positive impact in their lives. Outside of work, he’s a self-professed golf addict, foodie, and master taco maker.