In the investment world, volatility refers to changes in securities prices. These fluctuations occur every single trading day. An investment or asset class is considered very volatile if its price moves up and down frequently, sometimes by very large amounts. Volatility can be measured by tracking the movement of an investment’s or asset class’s market price over a period of time.
Volatility is Part of Investing
A decline in the Dow Jones Industrial Average might be a little scary, but you have to look closely to what is going on. Sometimes you may see the index go down several points but if you look at it from a percentage standpoint it may not be that significant.
Paper Losses Don’t Become Real Losses Until You Sell
While it’s certainly unsettling to see the value of your portfolio decline, it’s also important to remember that the decline is only a paper loss. It doesn’t become real until you decide to sell or redeem those securities.; If you hold on to them, they may be able to regain their value as markets move up.
Diversification is Key
While there is no guarantee, investing in a combination of stocks, bonds, and money market/stable value funds is a time-tested strategy for managing risk, and one that may even help improve returns over the long term. Diversification works under the principle that: when one asset class — stocks, for example — loses value, another asset class — such as bonds or cash — may deliver positive returns that can help offset those losses.
Moreover, you can achieve an additional level of diversification by investing in subcategories within asset classes. Stocks, for example, have many different categories: domestic, international, large capitalization, medium capitalization, and small capitalization. There are also stock mutual funds that invest in specific sectors, such as health care and telecommunications. However, diversification does not ensure a profit and may not fully protect against losses in a declining market.
With dollar-cost averaging, you invest a fixed amount of money regularly in shares of a stock or a mutual fund. When share prices fall and you continue your scheduled investments, you will buy more shares essentially taking advantage of a “sale” on securities.
Cyclical Versus Defensive
Some industries are notably affected by economic highs and lows. Cyclical stocks are sensitive to the health of the economy and include industries such as housing, transportation, and technology. Consumer demand for these products and services tends to rise when the economy is thriving and decline when it experiences a downturn. Defensive stocks are less sensitive to the economic health and include industries such as utilities, food, and other staples where demand tends to be relatively steady even in an economic downturn. Investing in both cyclical and defensive stocks from different industries may further improve your portfolio’s diversification.
Focus on the Long Term
When the market is volatile and unsettled, it’s important to remember why you are investing. Your long-term investment goals may include retirement, buying a second home, or paying for your child’s college. Historically, long-term investors who have adhered to their strategy, stayed calm and remained invested have done better than those who let their emotions take over their actions and jump in and out of the market during declines. See the chart for what can happen when you miss the market’s best-performing months.
Missing Top-Performing Months in the Stock Market
|Annualized Index Return / Potential Value of $1,000|
|30-Year Period (1988-2017)||20-Year Period (1998-2017)||10-Year Period (2008-2017)|
|Staying Invested||10.70% / $21,106||7.20% / $4,014||8.50% / $2,260|
|Missing Top 5 Months||8.91% / $12,933||4.77% / $2,538||3.77% / $1,448|
|Missing Top 10 Months||7.39% / $8,487||2.71% / $1,706||0.41% / $1,041|
|Missing Top 15 Months||6.03% / $5,789||0.93% / $1,203||-2.26% / $796|
|Missing Top 20 Months||4.78% / $4,059||-0.61% / $885||-4.42% / $637|
|This table summarizes the potential effects of missing top-performing months of the stock market, assuming investment performance mirrored the performance of the S&P 500.|