Creating a Plan to Face Stock Market Volatility

We've all experienced significant Wall Street fluctuations, whether during the 2008 stock market crash or the global economic reaction to the COVID-19 crisis.

If you have money invested in the stock market when volatility strikes, you might be wondering how to react to these events and what you should do with your investments. Should you buy more stock, hold onto what you have or start selling parts of your portfolio? Understanding the nature of market volatility and its potential impacts will help you decide what path is right for you.

What is market volatility?

When the stock market swings widely in the negative and then has a sharp recovery shortly after, it's in a volatile period.

There are a number of reasons this might happen. It can be due to an economic crisis, political unrest, company news or general market sentiment. Events like the Federal Reserve cutting interest rates, the nation's response to a natural disaster or changes within a major sector can all cause a domino effect in the market.

How volatility impacts stock portfolios

Stock market volatility indicates investors are reconsidering what stocks are worth, with the goal of determining their value more accurately. The more people buy and sell, the more accurate that price is.

When a stock market has a decline of 20% from 1-year highs, it's considered to be in a bear market, or a steep decline. This is the opposite of a bull market, when prices are rising and investors are confident. 

A big drop in the market usually happens at least every decade on average, with smaller dips happening on a more regular basis. Even when markets suffer a steep decline like they did during the 2008 financial crisis, stocks always recover after some length of time.

That's why it's important to think about investing for the long term. You may see an extreme up or down swing in the market one year, but the longer your money is in the stock market, the more likely it is that your portfolio will stabilize. Once that happens, it can start generating a steady return on your investments again.

What should you do when the market is volatile?

Everyone who invests in the stock market will eventually experience some market volatility. But there are a few things you can do to try to ride out the uncertainty and prepare before a down swing hits.

First, don't overreact. It's natural for the stock market to go up and down. If you sell all your stock at a loss today and those stocks recover next month, you'll likely regret it. Think about your long-term investing goals and set your strategies to reflect them.

If you have plenty of time until you retire, you may be able to handle the volatility of riskier stocks, because you have time for the market to recover before you'll need those funds. However, if you're closer to retirement, consider changing your investments to something more stable, like treasury bonds.

One potential trap to avoid is checking up on stock performance too frequently and making decisions based on short-term fluctuations. Over the course of a week or even a month, a particular stock might dip, so it appears you're losing money. But your investment may still be growing overall when seen from a longer-term view. Paying too much attention to small, day-to-day changes may create unnecessary stress and cause you to make short-sighted decisions.

The best way to ensure you can handle volatility in the market is to have a diversified portfolio. A volatile period could be a good time to look for value stocks, because high-value companies often are underpriced during market uncertainty. Just remember to only invest money that you have on hand and won't need for at least 5 years. Typically, investing based on long-term strategy and goals will help you see the best returns.

Stock market volatility is an inevitable part of investing, and it's outside our control. Having the right strategy and mindset can help you weather the storm. The key is to have a plan of action to minimize the impact of market changes on your portfolio.