Investing in the stock market has proven to be one of the best ways to grow wealth over the long term, with the S&P 500 historically delivering returns of 8–12% annually.1 While investing in stocks can be exciting, it can also wreak havoc on the nerves, particularly when the market is volatile.
While large institutional investors with significant resources are typically equipped to deal with volatility, big swings in the market can be extremely unsettling for ordinary investors. No one enjoys seeing drastic declines in the value of their 401(k).
The good news is that you can take steps to help insulate your portfolio against volatility and feel greater confidence in weathering stormy markets.
There are many factors that can cause markets to gyrate, sometimes mildly, sometimes wildly. Economic uncertainty is never good for the markets, and you’ll often see the market move on news about inflation, unemployment, consumer confidence, and other economic indicators.
Global events can have a huge impact, as we saw at the onset of the COVID-19 pandemic in March 2020. Global markets experienced significant swings as investors struggled to assess the long-term economic impact.
Investor sentiment, often driven by fear or greed, can have a strong effect on the market, as can changes in the regulatory environment or political instability.
The market hates uncertainty, which is one reason why the recent sweeping imposition of tariffs caused such upheaval. With the final level of tariffs on imported goods subject to change at any moment, companies and the analysts who cover them lack reliable data for their financial models. It’s impossible to make projections about international trade flows. Companies can’t plan for the future and analysts can’t create valuation models with confidence. The consequence is extreme volatility.
While volatility is a natural part of investing, there are steps you can take to help mitigate its effects on your portfolio.
Diversification is one of the most fundamental of all investment strategies. In simplest terms, it means “don’t put all your eggs in one basket.” This strategy entails investing in a variety of asset classes and types in order to reduce portfolio risk associated with price volatility.2 By spreading your capital among a variety of asset classes and types, you limit your exposure to any single asset class. When you spread your capital among asset classes whose performance is traditionally not highly correlated, the objective is to create a portfolio in which poor performance in one area can be offset by better performance in another.
In addition to diversifying by asset class, you can also further diversify within asset classes. For example, you might start by allocating between stocks and bonds. Next, within equities you can invest across industries, company size, and geographies.
However, keep in mind that while diversification is critical, spreading your investments too thin could lead to diluted returns and make it more difficult to manage your portfolio. Seek a balance that is consistent with your financial goals and risk tolerance.
This is some of the most important advice anyone can give you when it comes to investing. When you let your emotions take the wheel, the results can be disappointing.
It’s natural to feel anxious when the markets swing wildly and you see a mass of red when you check your portfolio online. What you must remember though, is that as long as you take no action, those losses aren’t real. They’re paper losses. They only become real when you sell.
We also discourage buying when the market is skyrocketing. Fear of missing out can lead investors to jump on the latest bandwagon without really analyzing whether that investment is a good long-term bet. Stocks whose gains are driven largely or solely by investor sentiment aren’t likely to stay up.
If there’s one thing investors shouldn’t try to do, it’s time the market3—and most emotional investing comes down to timing the market. We believe a better strategy is dollar-cost averaging. This involves consistently investing a fixed amount at regular intervals, regardless of market conditions. Over time, this approach may even help reduce the impact of short-term volatility and help investors avoid the temptation of buying high or selling low.
When you’re investing for long-term growth, remember that volatility historically has been a short-term phenomenon. Creating a written investment plan, particularly with the assistance of a trusted financial advisor, will help you establish clear goals, time horizons, and asset allocation targets that will guide you during volatile periods. A plan offers structure and can, if you can maintain the discipline to stick to it, help you avoid making impulsive decisions that are likely not in your best interests.
Your financial goals, time horizon, and appetite for risk should drive your asset allocation strategy. During periods of volatility, revisiting and adjusting your allocation may be necessary to protect your portfolio.
Reviews should entail rebalancing when necessary to restore your asset allocation to your stated target levels. For example, a rally in tech stocks could cause your portfolio’s equity allocation to increase beyond your target. If that happens, you’ll want to sell some stocks and reinvest the proceeds into bonds or other underweighted assets. Rebalancing helps maintain your desired level of risk.
It’s important to have a realistic idea of how much risk you can tolerate, both financially and emotionally. If market swings keep you on tenterhooks, you might want to reduce your allocation to riskier assets like growth stocks and choose lower risk alternatives. Just remember to balance your risk tolerance with your financial objectives. Risk and return are directly proportional.
Markets go up and markets go down. That’s reality. If you understand how the stock market has performed historically and what types of factors impact the markets, you’ll be more empowered to make informed decisions. Pay attention to current events, geopolitical news, industry fundamentals, and economic indicators. When you’re aware of what’s happening in the world, you’re less likely to be taken by surprise.
Remember as well that volatility isn’t all bad. It can also present opportunities. When markets decline, high-quality names may be available at low prices that can set the stage for future growth.
Market volatility is inevitable but that doesn’t mean you need to fear it. If you have a long-term plan, a balanced and diversified portfolio, a focus on long-term goals, and discipline, you’ll be positioned to ride out turbulent markets. Manage your emotions, stay informed, and make corrections as necessary.
You may find that the guiding hand of a trusted financial advisor makes it easier to stay the course. Remember, the best investors aren’t those who avoid risk, but those who are able to manage it thoughtfully and face it with discipline.