Stock market volatility may bother some people. It can lead them to make snap, emotional decisions. Impulse investing is counterproductive. It’s the opposite of careful, thoughtful planning. An ill-timed reaction to a volatile market may lead to a worse outcome than riding out the storm. It’s particularly unwise given how common market volatility is. Market volatility is a normal part of the way the stock market behaves. But because it’s so common, it creates planning opportunities and can be incorporated into your long-term investment strategy.
The Stock Market Rises and Falls
There is an old adage on Wall Street that says it’s not a stock market, it’s a market of stocks. On any given day, the prices of most of those individual stocks fluctuate. Some go up. Some go down.
On the days when those prices all seem to move together in one direction, folks say that “the market” did thus and such.
The big up days are typically characterized as “rallies.” But the big down days get labeled as being “volatile.”
So, the term volatility has become everyday lingo for a down market – especially one that makes the evening news.
Volatility and Long-term Returns
There is a relationship between volatility and opportunity. Volatile investments like common stocks have historically provided investors pretty attractive rates of return over the long haul. In other words, investors have been rewarded by owning common stocks for long periods of time. But there’s a cost.
Volatility can take a psychological toll on you in the short-term. It can be tough to see the value of an investment decline – even if that decline is temporary. To ease this burden, it helps to understand that volatility is inevitable.
It is also important to note that periods of market volatility (i.e., declines) have typically been followed by advances. And, while no one knows what will happen in the future, this cyclical pattern (of stock market declines and advances) has generally followed a mostly upward path for generations.
Stock Market Volatility and Long-term Goals
Investors with long time horizons, following a long-term financial planning strategy may be well served ignoring short-term bouts of market volatility. Staying the course may be an appropriate tactic. Here’s why.
Let’s say your long-term financial plan has you owning various stock mutual funds. You own them to help finance your future consumption goals. Then, one day the market gets volatile (you know, declines). Now, ask yourself:
- Has volatility changed your carefully considered goals?
- Has volatility changed your long-term plan?
- Has volatility fundamentally changed any of the funds you own (other than their price on that day)?
Odds are that the answer to each of those questions is no. So, why fret about short-term market volatility? An emotional reaction to it could create actual losses – from which you may not easily recover. That’s why staying invested when markets are turbulent may be appropriate for many long-term investors.
And in some cases, market volatility can create opportunity.
Capitalizing on Market Volatility
Staying the course doesn’t mean that you can’t use a market downturn to your advantage. There are a few things you can do.
- Rebalance your portfolio. As your investments change in value over time, rebalancing can help you get them back to a desired allocation. It includes selling assets that have increased in value or adding to assets that have declined in value.
- Go bargain hunting. A market downturn is like a flash sale – typically unexpected and often short-lived. While there’s no guarantee that that the price of any individual stock will go back up, a market downturn may present you with an opportunity to add desired investments at lower prices.
- Take tax losses. Selling investments that have declined in value may help you offset taxable gains created by selling other investments that have increased in value. Netting gains and losses may help you reduce your potential tax burden.
You’ll want to review these tactics with your tax advisor and a qualified investment professional to make sure they are compatible with your long-term financial and investment plan.
Factoring Volatility Into Your Planning
Market volatility also gives you the ability to blend your investment cost basis (what you pay for the investment) over time. This can be accomplished using an automatic investment plan (AIP). An AIP is a systematic program where a set amount (dollars or shares) of a specific investment is purchased on a regular basis.
An AIP doesn’t eliminate risk. It is just a technique to average cost over time. An AIP cannot assure positive investment results. Investments purchased using an AIP can still lose money.
The main benefit of an AIP is that It takes the emotion and guesswork out of the investment decision. Investments are made automatically, without regard for price. They just happen. So, an AIP may be one way to navigate periods of market volatility.
To learn more about market volatility, speak with one of our Representatives. They’re available at (800) 235-8396.
