Key Takeaways:
- Market volatility, or fluctuations as simply defined, is inevitable.
- Diversification across investments and time is a crucial mitigant against market volatility.
- Volatility may also create opportunities that investors can capitalize on after thorough research.
Fluctuations, or volatility, in investment portfolio prices can be very uncomfortable. Most of us will remember the drastic dips in the stock market (and, hopefully, the incredible surges too). While the discomfort is warranted, volatility is not only outside of our control, and it is important for us as investors.
What is volatility?
A simple way to think about volatility is that volatility equals fluctuations. Greater volatility means deeper and wider changes – whether gains or losses in value.
For example, a stock with high volatility means that its price may change rapidly and in big swings. High volatility means greater potential for sudden gains or losses. Likewise, a stock with low volatility means it’s relatively stable, and its price may not change much from one period to the next.
What to do about it?
Volatility in the markets is inevitable. Markets and valuations move. There are a couple of concepts to remember and actions to take related to volatility.
1. Diversify portfolio (and review modern portfolio theory; see here)
As we explored before, diversifying a portfolio across and within asset classes reduces volatility and better achieves an efficient risk-reward profile. It may make sense to review your portfolio to make sure you are properly diversified in the context of your goals. There are free resources to help out here!
2. Short-term volatility is just that – short-term.
Short-term volatility can sometimes be wide swings – often moving a particular position from gain to loss (or vice versa). For example, the S&P 500’s peak to trough due to the COVID19 pandemic was a painful ~30% decline over slightly more than a month.
However, that dip was short-lived. S&P 500 reached record highs a couple of months later.
3. Remind yourself that volatility can be an opportunity.
Volatility creates opportunities. The obvious type is in the example mentioned above about the S&P 500. If an investor had the conviction of a market recovery and “bought the dip” early in the COVID pandemic, the investor would have made healthy returns over a short period.
More broadly speaking, fluctuations in prices can temporarily create undervalued assets that can generate exceptional returns.
An average investor can take advantage of these fluctuations by investing routinely. Here’s an example.
Let’s assume an investor invests $100 every week into a stock over the next five weeks and that the stock price moves from $100 to $120 over this time. Let’s further assume that the stock price moves in two ways: path A is linear growth and path B has some volatility. Here’s a comparison of the outcome.
Path B results in more gains! This example illustrates another reason why diversifying across time is also an important consideration.
4. Get professional help or use a robo-advisors
Volatility may cause a lot of unwanted anxiety and stress. It might be worth it to engage a professional financial advisor who can help consult you through market changes. It also might be beneficial to establish a “set it and forget it” strategy with a robo-advisor that rebalances and diversifies your portfolio without requiring your daily attention.
The stock market has seen extreme volatility this past year (and continues to be!). These fluctuations can be very uncomfortable. Hopefully, this article lays out several things you can keep in mind and do in the face of market turmoil.
Disclaimer: The contents of this website is an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.