How you can deal with market volatility
Market swings can be troubling when it comes to your money. Instead of being worried, the best course of action is to be prepared. The good news is that there are strategies for dealing with market ups and downs. Strategies you can follow to ensure you haven’t taken on too much risk, and that help you focus on what matters when your news feed is filled with scary messages about struggling markets.
“The stock market is the story of cycles and of the human behaviour that is responsible for overreactions in both directions.” – Seth Klarman.
Focusing on the long game
Market volatility is unavoidable. It is part of normal and healthy market behavior. Just like seasons, markets move through stages of growthOpens a new website in a new window - Opens in a new window, slowing down and speeding up. Unfortunately, the timing of those cycles are unpredictable. While dramatic moves in the market can make you question your investment plan, it’s important to remember not to panic. When the market does drop, the historical facts show that eventually it always comes back even stronger. Markets generally correct after a big decline. Based on historical dataFootnote 1, average downturns of 21.9 per cent are likely to return to normal – or better – within 12.8 months.
While it’s natural to want to protect your portfolio after a market decline, it also raises the question of when to get back in. As shown in the below chart, here is why it doesn’t work successfully for most investors. By missing the best weeks in the market, investors greatly affect their potential returns. For example, an investor who stayed invested in Canadian equities over 20 years would have seen their $10,000 investment grow to $41,402 (total return). If that same investor, missed out on the best week, their $10,000 investment would only have grown to $36,619. Keeping focus on your long-term investment goals can help quiet the media noise around falling markets and help prevent you from making rash investment decisions that don’t follow your plans.
Asset allocation and being diversified
DiversificationOpens a new website in a new window - Opens in a new window is a core technique for reducing risk. Holding a variety of investments can help lower the emotional impact of panic or fear if one of those investments gets into trouble. Over time, stocks are seen as offering the most potential for increasing in value. However, there’s a reason you read about stock markets shooting up or plunging down – stocks also have more risk. They are a common investment in Canada, but for most people, they are not the only asset class you’ll want to hold. In order to create a portfolio with stable returns, you’ll want to expose yourself to more than one asset class because you can’t predict which one will do best year-over-year. Many people also invest in bonds, which are typically less volatile but offer less potential for returns, or other assets such as cash, government bonds or money market instruments, which offer very little lower volatility alongside very little return.
While the mix of these different asset classes in your portfolio is called diversification, choosing an asset allocation that makes sense for your own financial situation including how old you are, what kind of returns you need (and when) and how much risk you can handle is important.
Your asset allocation strategy can vary from a portfolio full of start-up stocks with big potential for growth to putting all your money in a high-interest savings account. (In that case, your investment growth may struggle to keep pace with the rate of inflation) The ideal asset allocation is probably somewhere between the above two extremes. A trained investment professional can help you align your personal financial goals with your investments. Having a sound investment plan will help you focus on the long-term despite short-term changes in the market.
Reviewing your investment plan regularly and sticking to it
Do you have an investment plan? If you do, great. That’s half the battle. The other half is remembering to review it, update it and most importantly, to stick to it.
Determining your asset allocation is only the beginning of a properly managed portfolio. Over time, a portfolio can become distorted, especially when equity components do better than fixed income-investments.
One of the things that determines your investment personality, and ultimately what your retirement savings plan might look like, is your tolerance for the risks associated with investing. Take our Investment personality questionnaire to help you determine your risk profile.
An advisor can help with all of this and the value of talking to an expert is very important. Not only will they help you stick to your investment plan, but there’s also a good chance you’ll notice an improvement in your investments over time by remaining with an advisor. Those that used an advisor for more than 15 years saw their investments grow by more than double than those that had one for four years, according to a study.Footnote 2
- Footnote 1
- 1 Source: Datastream and Bloomberg. Benchmark: S&P 500 Composite, US$ return. April 30, 2022.