The stock market can seem like a constant roller coaster. Every day there are reasons for it to go up and reasons for it to go down.
If you’re a self-directed (DIY) investor, you probably keep close tabs on the stock market, trying to figure out if you should be touching your portfolio.
Should you rebalance?
Should you move away from that one stock that was in the news today? Or should you buy the dip?
The stock market and economy, in general, are cyclical. What goes up (usually) must come down. These movements are not unexpected, nor are they new. As new information or new players enter the market, the stock market can move in either direction.
We can try to refer to historical events. But the stock market is trading on the future potential of these companies.
Any news that could impact a company’s future or the economy at large can cause ripples and bumps in the stock market.
It would be great if the stock market only went up. But unfortunately, it must also go down.
Market volatility is a well-accepted side effect of investing in the stock market. And we bear it because the stock market has consistently been one of the best investments for our generation.
Historically, the alternative to stocks is investing in bonds – but most investment-grade corporate bonds offer yields of just 1.5%.
What else can you do? Leave your money in the bank? But you would be losing about 2% annually thanks to inflation. And potentially, even more, based on recent data.
The stock market has been a source of wealth, on average, beating inflation. The average annual return of the S&P 500 from 1957 through 2018 is roughly 8%.
So we have no choice but to invest in the stock market and weather the ups and downs, also known as market volatility.
What is market volatility (really)
In technical jargon, volatility is a statistical measure that helps gauge how risky a security (or stock) is, based on movements in price compared to its average price.
It can help reveal how predictable the short-term value of the stock might be.
So when a stock trades at higher highs and lower lows, it is considered more volatile. When it trades around a more stable price, is it less volatile.
You can even measure volatility for the entire stock market.
And, the VIX, or the Volatility Index, is one measure of market volatility based on how option futures are trading. You can read up more on the VIX here.
Generally, VIX values greater than 30 can point to significant volatility, while VIX values below 20 typically point to a more stable, stress-free market.
Why does Volatility matter?
If you are a risk-seeking individual, you are going to LOVE volatility.
Volatility creates opportunities because there is a greater range of prices that stocks are trading at, so there is a greater chance of being able to buy low and sell high – if you time it right (of course) – and score a great deal.
The downside? It also increases the chances of buying the stock at a higher price, and then that stock could drop much lower.
On the other hand, if you are a risk-averse person and view the stock market as a place to park your money long-term, you probably don’t want to see large fluctuations in pricing. You would rather see slight (hopefully positive) changes in your portfolio.
The average investor cannot influence volatility in the broader market. But we can make choices in our portfolio to ensure that we are not adversely affected by the volatility in the market.
Managing Volatility in your own portfolio
If you’re a long-term investor – of course, you want a good upside but be protected against the downside.
Here are a few strategies and tools that can help create a less volatile portfolio, so you can soundly sleep at night!
Diversify your holdings
Diversification is arguably the best strategy for managing volatility.
Diversification is an investment strategy where you hold various investments in your portfolio not to be affected by movements in only one stock.
Investment professionals have different recommendations and guidelines to determine if your portfolio is adequately diversified. Some studies suggest 20-30, while others recommend a number closer to 50 companies.
However, the general idea is to invest in various types of investments that don’t rise and fall simultaneously for the same reasons.
Here are some suggestions to consider in diversifying your portfolio:
- hold other types of investments (like real estate or bonds) along with stocks (like a traditional 60/40 portfolio)
- hold stocks in a variety of industries (so that they don’t move together)
- invest in index funds or ETFs (so you can hold multiple companies without purchasing each separately)
Evaluate your concentration
If you look at your current holdings and find that you have too much of one stock, one industry, it could be time to add more or diversify your holdings.
Rebalance if needed
Sometimes, when growth stocks increase in value more than the average stock market, it can throw off your diversification strategy. In that case, you may want to consider selling a portion or adding more funds into the portfolio to continue to be diversified.
Once you set up a diversification strategy, it is vital to periodically re-evaluate the plan and your positions.
Find comfort in History
Lately, the stock market has seen more volatility. In 2019, the average closing price of the VIX was 15.39, and in 2020 it was 27.98.
Don’t let volatility scare you in and out of the market. The stock market value, though, has also been on a general uptrend. In 2020, the S&P finished with a gain of 16.26%.
If volatility scares you, look at this set of data going back to 1930. If an investor missed the S&P 500′s 10 best days each decade, the total return would be 28%.
On the other hand, the investor held steady through the ups and downs; the return would have been 17,715%.
The lesson here?
Don’t try to time the market. And don’t let market volatility scare you into leaving if you can afford to; stay and ride the roller coaster of market volatility!
Invest consistently
The average person is unable to time the market. And in fact, some studies show that professionals are not able to time the market either!
According to Morningstar, actively managed portfolios that moved in and out of the market between 2004 and 2014 returned 1.5% less than passively managed portfolios.
So rather than trying to time the market, the best way to get the best price is to invest consistently.
Whether that is monthly, bi-weekly, quarterly, whatever works for your investment strategy. Robo-advisors have made this easy – such as Wealthsimple Invest and Questrade Portfolios in Canada.
Manage your emotions
A volatile stock market is ripe for losing sleep over your investments.
Keep a check on your emotions to make sure you are not making decisions out of fear or greed, or other emotions. But instead, you are making decisions using logic and based on the facts you have.
Are you a trader or investor?
Whether you call yourself a trader or investor is a vital question when purchasing any stock.
It can determine how long you plan to hold the stock. If you are a long-term investor, daily movements in the stock market should not concern your investment strategy.
Most people should be long-term investors and not traders. Here’s the distinction, if you are interested.
Limit your exposure to trendy/”fun” assets
Cryptocurrency and Meme stocks have taken center stage recently. If you were able to time these trades at the right moments, you, of course, would benefit from their volatility and significant upside. But with any significant upside, there can be a considerable downside.
If you do plan on investing in these meme stocks, understand your risk exposure. There is nothing wrong with allocating a small part of your portfolio as the “fun portfolio.” The question to ask yourself is, can you afford to lose it?
If you are an active investor, make sure to put limits in place, either on your trading platform or by creating a trading plan to exit each trade when appropriate for you.
Final Thoughts on Market Volatility
Unfortunately, market volatility is part and parcel of being invested in the stock market.
There is an inherent risk, but if you take precautions, the market volatility can reward you for your time in the market by helping you grow your wealth and reach your financial goals.