There’s no doubt stocks have been experiencing considerable volatility lately. The CBOE Volatility Index has seen multiple days with extremely sharp moves, the most since 2014. After years of low volatility, it was merely a matter of when, not if, the markets would experience a rise in volatility. Higher volatility reflects greater price swings in both positive and negative directions and is a general measure of risk and uncertainty about the future direction of the markets. The recent rise in volatility has been driven by a number of factors. Concerns that drove the stock markets lower last month included an announcement by the Trump administration that it would impose roughly $50 billion in tariffs on imports from China, tech giant Facebook lost over $60 billion in value after the company came under fire for failing to protect users’ data, and the Federal Reserve elected to increase interest rates. While any of these incidents alone would cause some reaction from the markets, they all came in quick succession, causing the markets to fluctuate significantly.
As investors, it is important not to overreact to this outside noise and stray from your investment strategy in the face of volatile markets. Acting based on emotion and fear can cause you to make mistakes that can negatively impact your long-term investment performance. During periods of higher volatility, consider some of the following tips:
- Fight the impulse to sell your holdings if the markets are dropping. Selling after drops can make temporary losses permanent and difficult to recover from. Sticking to your investment strategy, while difficult emotionally, may be healthier for your portfolio. Although monitoring your investments is important, keep in mind the long-term reasons they are in your portfolio. What role is each security playing? If it is still a good fit, holding the investment may be the better long-term strategy.
- Remember that you are investing for the long term. Markets have always fluctuated up and down, and during your lifetime you’re likely to experience several significant declines. Timing when the market has hit a bottom is nearly impossible. Investors should ignore the noise and stay disciplined to the investment strategy they designed. The strategy was created specifically to avoid falling into these pitfalls.
- Review your risk tolerance. Risk you took on years ago may no longer make sense given your current circumstances and life stage. If you are less open to risk, consider adjusting your target asset allocation.
- Make sure your portfolio is well-diversified. Volatile markets can expose improperly diversified portfolios. Review your portfolio and target asset allocation and make sure your investments are well-diversified across a range of asset classes.
- Rebalance your portfolio. Market volatility can skew your allocation from its original target. Certain assets will be more affected by market swings and will move outside their target allocations. Resolve the imbalance by selling positions that have become overweight in relation to the rest of your portfolio, and invest the proceeds in those positions that have become underweight.
- If you must trade during volatile markets, there are defensive steps you can take to protect your positions. Stop orders and stop-limit orders can help shield unrealized gains or limit potential losses on an existing position.
- Consider adding defensive assets to your portfolio. Defensive assets, such as cash and cash equivalents, Treasury securities and other U.S. government bonds, can help stabilize a portfolio when stocks are slipping.
Following these tips will help you stay disciplined in your investment strategy and avoid making emotional mistakes.
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