Looking back at the past few weeks, the market has made some investors nervous. Market volatility can lead to some serious stress but what are the best ways to respond to this uneasy feeling? When dealing with market volatility, it’s important to keep several things in mind to avoid making major mistakes.
Have a Plan
It’s frequently said that those who fail to plan are planning to fail. When investing, it’s important to have a plan. If your plan is to put $1,000 or $5,000 a month stick to it. Slow and steady wins the race. Sticking with your plan will allow you to take advantage of the periods when the stock market is down.
Dividends and interest tend to keep coming whether the Dow Jones Industrial Average is down 500 points or it’s up 300 on a given day. It’s true that there are situations that will lead some companies to cut or suspend their dividends. However, most companies will keep paying out dividends as long as possible because a cut is a sure-fire way to lose investors and see the price of your company’s stock drop like a rock. Dividends from stocks and interest from bonds are two of the best ways to deal with volatility. You should keep reinvesting the capital your investments throw off. When the market is down, you’ll be able to buy more shares, and this will add to your flow of dividends and interest. By reinvesting during periods of volatility, you’ll be able to increase the power of compounding greatly.
Many financial professionals will tell you to avoid selling your investments at the worst possible time is a part of sticking with your plan. Often times, this is an ideal strategy. It can be tempting to sell when the market is down 10% so that you can avoid the next 20% loss. This is generally a bad idea. Time in the market will usually beat attempts to time the market. Although, one exception would be drawing down some money strategically during your golden years. You’ll probably want to make quarterly or annual withdrawals regardless of what the market is doing in that case so that you can fund your living expenses.
Another important step to take when the market is showing extreme volatility is remembering to rebalance your portfolio periodically. You may have a strategy of rebalancing quarterly, semiannually or yearly. If you have a target allocation of 75% of your portfolio in stocks and 25% in bonds, a major drop in stocks could leave you with 65% in stocks and 35% in bonds. In this instance, you’d sell a chunk of your bonds and move the money into stocks. If you’re still in the accumulation phase, you could stop contributing to bonds and put all of your money in stocks until you reach your targeted balance. This will keep you from becoming too overweight in one area and allow you to maintain the proper level of diversification.
One big piece of advice that’s important to remember during market volatility is to stay the course. If you have a plan, stick to it. This includes making periodic investments as you would if the market were at record highs. Real money is made during market downturns. If your portfolio gets out of balance, it’s a good idea to rebalance it in the event of a major market downturn to take advantage of the sale price on stocks. If you have cash sitting on the sidelines, volatility to the down side can be a great time to put that money to work.