Bouts of stock market volatility are an unnerving, but normal, feature of long-term investing. They're not fun, but you can expect to see market declines periodically throughout your investing career.
But it's hard to sit still when stock prices are sliding. You can't help but think: "Shouldn't I be doing something?" Every investor is different, but here are a few things that everyone can consider during market volatility.
Resist the urge to sell based solely on recent price movements
Selling stocks when markets drop can make temporary losses permanent. Staying the course, while difficult emotionally, may be healthier for your portfolio. This doesn't mean you should hold on blindly, but we suggest taking into account an investment's future prospects and the role it plays in your portfolio, rather than being guided by noise and fear.
Take the long view
Markets typically go up and down, and you're likely to experience several significant declines during a long investing career. But even bear markets—that is, periods when the market fell by more than 20%—historically have been relatively short when compared to bull markets. Because timing the market's ups and downs is nearly impossible, all investors would do well to ignore the noise and stay focused on their plans.
Review your risk tolerance and your risk capacity
Risk tolerance is your ability to emotionally handle big price swings; risk capacity is your financial ability to take a loss. Market downturns can be a wakeup call to reconsider your risk tolerance, although we recommend waiting until you're calm. Risk capacity, however, can—and should—be considered at any time. Do you have enough liquidity to handle near-term goals? Money that you’ll need soon or that you can't afford to lose shouldn't be in the stock market—it's best invested in relatively stable assets, such as money market funds, certificates of deposit (CDs), or Treasury bills. If you're retired, having your next 12 months of living expenses in a bank account or money market fund—and a few more years' worth in bonds that mature when you need the money—can help you stay calm when stock markets are not.
Make sure you have a diversified portfolio
Volatile markets also can reveal that portfolios their owners thought were appropriately diversified in fact aren't. If you haven't looked at your portfolio recently to make sure you understand what each asset class is doing and that the mix matches your target asset allocation, now is a good time to become reacquainted with it.
Consider including defensive assets for more stability
Defensive assets, such as cash and cash equivalents, Treasury securities and other U.S. government bonds, can help stabilize a portfolio when stocks are slipping. Also, if you expect to spend from your portfolio within the next few years, it's a good idea to keep that money in assets that historically have been relatively liquid and less volatile than stocks, such as cash and short-term bonds. This can help you avoid having to sell in a down market.
Rebalance your portfolio as needed
Market changes can skew your allocation from its original target. Over time, assets that have gained in value will account for more of your portfolio, while those that have declined will account for less. Rebalancing means selling positions that have become overweight in relation to the rest of your portfolio, and moving the proceeds to positions that have become underweight. It's a good idea to do this at regular intervals.
Adapt your trading to fast-moving markets
If you must trade during volatile markets, take current conditions into account when entering orders. Be careful when trading during the first and last hours of the trading session, which tend to be the most volatile. Trade smaller positions, and consider "scaling" in or out of positions by buying or selling stock in increments as the price fluctuates. There are defensive steps you can take to protect an unrealized gain or limit potential losses on an existing position, such as stop orders and stop-limit orders. These can help make your decision-making more automatic and less reliant on doing the right thing in the heat of the moment.
The bottom line on market volatility
Markets rise, and markets fall. While price changes and fluctuations are inevitable, down markets can be stressful. Concerned investors can ease their worry during down markets by revisiting their financial goals and understanding their asset allocation, diversification, cash flow needs, risk tolerance, and risk capacity before making any changes to their portfolio, financial goals, or asset allocation.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Past performance is no guarantee of future results, and the opinions presented cannot be viewed as an indicator of future performance.
Investing involves risk, including loss of principal.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Lower rated securities are subject to greater credit risk, default risk, and liquidity risk.
Diversification and asset allocation strategies do not ensure a profit and do not protect against losses in declining markets.
Rebalancing does not protect against losses or guarantee that an investor's goal will be met. Rebalancing may cause investors to incur transaction costs and, when a non-retirement account is rebalanced, taxable events may be created that may affect your tax liability.
There is no guarantee that execution of a stop order will be at or near the stop price.
Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. For more information on indexes, please see schwab.com/indexdefinitions.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.
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