How to Cope With Market Volatility
When you’re watching your favorite financial guru on TV and he says “the markets are up” you are happy. But when he tells you the markets are down you are not so happy. These may be normal reactions for some people, but when you know your goals and have established your strategy, you can turn off the TV and handle the market volatility without all the emotional uncertainty.
To the novice the thinking goes: If the markets are up, then I have more money. If the markets are down then I have less money. While those statements may be true at the moment, it’s also a condition that changes day to day.
When the market crashed in 2008 was it permanent?
The answer is, no. The markets are now higher than they have ever been. People mistakenly get caught up in the day-to-day changes in the market, but what impact does that really have on their goals for the future?
The longer you have until you need your savings, the less short term volatility will affect your investment. If you have less time until you need to rely on your savings, the more risk averse you should be, because you have less time to recover from volatility in the stock market. Knowing your goals can help with your expectations, because you can define the amount of risk or volatility that you’re willing to be exposed to.
Asset allocation controls risk
Here’s an example. If you are properly diversified and 100% of your savings is invested in stocks and the market drops 30%, then your savings will likely be down about 30%. But if you have only 50% of your savings invested in stocks and the other 50% invested in fixed income, and the market drops 30%, then your savings will likely only be down about 15%. Asset allocation is the best protection against short term volatility.
What does that mean for return?
By having less exposure in stocks we also give up less opportunity for a higher return from a historical perspective. The fixed income will provide less return, because we give up the opportunity for return in order to have the comfort of knowing savings will be there when it is needed. It’s give and take, fear and greed. By understanding long term goals and adjusting your asset allocation accordingly you can turn off the television and ignore what your friends are saying about market activity. Diversify in individual stocks and bonds, and gain an understanding of what you own. The ability to control what you own can help control your long term outcome, and eliminate the emotional roller coaster.
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