While market volatility can be painful, it can remind investors of the importance of sticking to the fundamentals.
Market volatility, painful as it can be, can actually provide an important lesson for investors about why it’s important to stick to the fundamentals, such as having an asset allocation strategy and regularly reviewing your plan. With that in mind, here are suggestions for these turbulent times that may help you turn today’s worries into tomorrow’s good habits.
Remembering asset allocation
When market volatility occurs after an extended period when the economy and markets have been on the rise, as they were over the last 10 or so years, investors have the opportunity to get back to fundamentals they may have forgotten. This is especially true for asset allocation—the strategy financial professionals return to time and again when investors want help dealing with volatile markets.
At its most basic level, asset allocation is how you diversify your investments across different asset classes (stocks, bonds, cash alternatives, etc.). This varies based on a number of factors, primarily:
- What you want your investments to help you achieve (objectives)
- How comfortable you are with market volatility (risk tolerance)
- How long it will be before you will need to access your investments (time horizon)
The asset allocation model that best suits any given investor depends on where they land in regard to the three factors above.
It’s important to remember that asset allocation offers investors a trade-off. During good times, a diversified portfolio’s return will lag the best performing asset class. On the other hand, during down periods, it will do better than the worst performing asset class. It’s up to each investor to decide what’s more important—participating more in the good times by holding more stock or avoiding the worst of the bad by holding less.
Reviewing your plan regularly
If you have an asset allocation plan and still find yourself lying awake at night, this is a chance to revisit your plan for possible adjustments.
It’s possible you overestimated your risk tolerance when creating your plan. Due to their potential for providing growth and, sometimes, income, stocks have an important role to play in many plans. But with that potential comes the likelihood for greater price volatility than is typically seen with other investments, such as bonds. If concern about your investments is causing you stress, this may be your opportunity to see whether it’s time to scale back on how much you have allocated to stocks.
It’s also possible that market activity shifted your allocations away from your targeted amounts. Say you started with a hypothetical portfolio of 60% stocks/40% bonds. The rise in the stock market over the last several years may have shifted it to, for example, 75% stocks/25% bonds, which means you would experience more of the market’s volatility than you intended.
You may also want to consider rebalancing your portfolio regularly. Rebalancing is simply checking your investments to see whether market activity has caused them to drift. If they have, you can decide if you want to sell investments that have increased in value and use the proceeds to buy others that may have decreased. Doing this at least once a year – or allowing your investment platform to do that for you — can keep your allocations—and risk level—where you want them.
Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.
All investment involves risk, including the possible loss of principal.