How to Navigate Market Volatility

Key Points

• Market volatility measures the frequency and intensity of stock market price movements. 
• Investors can use volatility strategically based on their unique risk tolerance.
• Avoid panic selling or attempting to time the market during volatile markets; you’re more likely to see missed opportunities or losses.

Volatility refers to the degree of variation in the price or value of an asset, security, or market over a specific period, typically measured by the standard deviation or variance of returns. It reflects the level of risk or uncertainty associated with the asset's price movements. High volatility indicates larger price swings, while low volatility suggests more stable prices. Managing volatility is an essential consideration for all investors, but especially those getting closer to retirement. 

A wide number of fundamental factors can create volatility, ranging from economic conditions to earnings reports. And while market volatility can cause investors to pause before entering or exiting a position, there are multiple investing strategies that benefit from quick, short-term price movements. Volatility is not inherently positive or negative, and there are ways to limit the impact of volatility on your portfolio. 

Keep reading to learn more about how understanding your risk tolerance, diversifying your portfolio, and implementing effective strategies can help you confidently navigate and manage market volatility.

Understand Your Risk Tolerance and Goals 

How much volatility is too much? The answer will vary depending on your unique risk tolerance, i.e., your comfort level when putting money into markets. Volatility tends to be associated with risk and return—meaning that your financial goals will play a major role in the ideal volatility for your portfolio. 

For example, if you’re a younger investor, you likely have decades of time left in the market to build wealth. This means your risk tolerance is higher than that of an older investor who is approaching retirement. Defining your investment goals, using a risk questionnaire or consulting with a financial advisor can help you determine your risk tolerance. 

Key Strategies for Managing Volatility

Anticipating and managing portfolio volatility becomes more important as you get closer to reaching your financial goals. Use these strategies to incorporate volatility into your investment portfolio at a level that’s suitable for your risk tolerance. 

Diversify Your Portfolio

A diversified portfolio helps mitigate the impact of volatility by spreading investments across various asset classes and companies, with each class representing a certain level of volatility. For example, growth stocks like tech stocks tend to show more volatility than consumer staples stocks due to their cyclical nature. Younger investors with higher risk tolerance levels may want to skew assets toward growth stocks while also maintaining a basket of stable assets to lower the overall risk of loss. 

Allocate Assets Strategically

Strategic asset allocation involves tailoring your portfolio to match your risk tolerance and financial goals and reallocating assets as your needs change. For example, stocks tend to be more volatile than bonds because they don’t have financial guarantees from issuing bodies. If you’re looking to control volatility, you might invest a higher percentage of assets into stable classes like bonds and real estate. 

Get Defensive

A simple way to introduce stability to your portfolio is by investing in a defensive exchange-traded fund (ETF). ETFs hold a series of stocks split among all investors who own shares of the fund, adding instant diversification to your portfolio without individual company research. An example of a defensive ETF is the Invesco S&P 500 Low Volatility ETF (NYSEARCA: SPLV), an S&P 500 index fund weighted to favor less volatile companies. 

Hedge Your Risk

“Hedging the market” is an investment strategy that incorporates asset classes that traditionally profit when the overall market is down. Examples include put options and inverse ETFs, which are designed to mirror the opposite performance of major indexes. While these assets can be beneficial during periods of economic stress, they tend to perform poorly when the market is doing well and should be used with caution. 

Stay Focused on Your Long-Term Goals

Short-term market fluctuations are common, but over time, a well-diversified portfolio can smooth out these ups and downs with stabilized growth. Historically, markets have shown resilience, with diversified portfolios often recovering from downturns and generating positive returns over extended periods.

By avoiding the urge to react to day-to-day market swings, you keep your portfolio aligned with your ultimate financial goals rather than being influenced by temporary market movements. Reacting impulsively to short-term volatility can lead to costly decisions like selling at a low point or missing out on the subsequent recovery. Check your portfolio only as often as you need to, and resist the temptation to impulsively sell. 

Common Mistakes to Avoid During Volatile Markets

Volatile markets can be notoriously difficult to manage, especially if you check your portfolio regularly. Avoid these three common mistakes to see better returns over time. 

1. Panic Selling

During uncertain market periods, investors often panic and sell off investments at a loss, believing that prices will continue to plummet indefinitely. Historically, markets have recovered from downturns in every major sector. Panic selling locks in your losses, preventing you from benefiting from market recovery. Stay calm, focus on long-term goals, and avoid making investment decisions based on fear, especially during periods of high volatility. 

2. Trying to Time the Market

Investors who “time the market” try to strategically make investments when the market is low with the intent to sell them off when prices rise. While this strategy sounds like a good idea, most investors are not able to accurately predict price movements, leading to missed opportunities and compounded losses. Dollar-cost averaging, which involves consistent purchases over time, usually results in better long-term results.  

3. Overreacting to News

Reacting to market news or financial headlines can lead to impulsive decisions, causing you to enter or exit positions without considering the full consequences of doing so. For example, if you read negative headlines about a stock and decide to sell, you might need to pay higher taxes if you haven’t held the asset for one year or more. 

Staying Steady in a Volatile Market 

While market volatility is an inherent part of investing, it doesn’t have to derail your financial goals. By understanding your risk tolerance, diversifying your portfolio, strategically allocating assets, and staying focused on long-term objectives, you can mitigate the impact of volatility and make more informed investment decisions. Avoid common pitfalls and maintain a steady, disciplined approach to your portfolio. With careful planning and a focus on your financial goals, you can confidently navigate periods of market fluctuation and position yourself for long-term success.

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