Your Portfolio & Market Volatility

Over the years, many investors have developed a low tolerance for market volatility. As a result they often move portions of their portfolios into bonds or other lower risk vehicles during turbulent periods.

What these investors may not realize is moving from one asset class to another in order to avoid volatility may actually increase portfolio risk. Investors with a long-term horizon have actually benefited from volatility over the last decade as it is a key driver to market gains.

Unquestionably, the stock market has experienced plenty of ups & downs in the last 10-20 years. Historical data reflects market corrections are normal and thus favor the long term investor. 

Winning with Market Volatility

Since World War II, the stock market has experienced, on average, an intra-year decline of 14 percent each and every year; and in that same period, the market ended lower, on average, by 18 percent every third year. Bear markets, with an average decline of nearly 30 percent, have occurred every fifth year. Yet, over that same span of nearly seven decades, stock market values have grown 100-fold, which means that, $1,000 invested in the stock market 70 years ago would have grown to $100,000 despite the periodic market declines.

The very profound and highly instructive take away from this is that market declines have, thus far, been nothing more than a momentary interruption in an enduring market advance. Hence, volatility is simply a necessary phenomenon of a functional market. On the other hand, market risk – the risk of incurring losses as stock prices fall – is often human-induced. The only way investors actually lose money is when they sell their stocks.

Those who are suddenly spooked into bailing out of the market after it has already fallen 10 or 15 percent, will usually lose money. Yet, history shows that the stock market rewards investors who can bear the volatility of stocks and avoid the harmful behavioral traps through various periods of performance.  So, the real risk to investors isn’t being in the next 20 percent market decline, its being out of the next 100 percent market increase.

Building Your Portfolio around Market Volatility

Proper Diversification

Proper diversification is the key to withstanding increased volatility and reducing downside exposure. A well-diversified, strategically allocated portfolio will almost always decline in value less than the stock market indexes. If your portfolio only declines 7 percent while the stock market declines 12 percent, you’ll have less to recover when the market rebounds.

Focus on your Long Term Objectives

During periods of increased market volatility it does little good to worry about the market-shifting macro events of the day that will have little or no impact on the long-term performance of your portfolio. The stock market decline of 2008 will turn out to be nothing but a small blip for a portfolio invested for 20 years.  It took years for the investors who fled the market in 2008 to recoup their losses, while those who kept their sights on their objectives and stayed the course have enjoyed record gains in their portfolio.

Patience and Discipline

Volatile markets can cause investors to make costly mistakes, such as trying to time the market (which is very difficult at best), or chasing performance, or trying to pick the winners. These mistakes can cost investors a significant portion of their portfolio value. It takes patience and discipline to adhere to a strategy and avoid the herds. Stocks should be deliberately bought and sold according to a strategy, not in response to emotions.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2024 Advisor Websites.