Understanding volatility

The ups and downs of being an investor

Not-so-fun fact: The stock market’s going to rise and fall. Some dips will be minor, some will be major, and some might make you nervous about the very idea of investing. But even the most extreme fluctuations don’t have to be fatal to your finances. You can plan for the ups and downs and invest in a way that will help you ride it out.

Meet the moody market
If you could chart the ideal investment performance, it would move steadily upward over time. A chart of the stock market looks very different. For one thing, what we call “the market” is usually a representation of a limited number of stocks, called an index. The Dow Jones Industrial Average or “the Dow,” an index of 30 closely watched companies, is one popular measure of the market. Its performance can be more erratic – it may move up a bit, then down a bit, then up some more and so on.

That erratic behavior is volatility. It’s a normal part of what the market does, and it helps keep investment prices in line with reality. In fact, economists refer to big market downturns as “corrections.”

While it’s true that ups and downs have been an unavoidable part of investing in the stock market, steep drops in value can be stressful to even the most seasoned investors. But when the Dow takes a dive, it can be a good idea to stick with an investment strategy designed to weather declines over time.

Why stay invested when your instincts say it’s time to go? Because it’s nearly impossible to tell if a dip is temporary or a sign of a correction to come. Sometimes markets rebound quickly; other times the dips are more prolonged. Try to guess the market’s next move by cashing out and you may miss a chance to recover losses. You also miss being part of potential upswings. And while you occasionally may want to buckle your seatbelt for a bumpy ride, history shows us the general trend of the market has been positive.

Coming to terms with volatility
Although volatility is inevitable, there are a few ways you can lessen its impact:

Broaden your investments. Bonds can be less volatile than stocks and have their own market cycles. They are often up or steady when stocks are down. By investing in a mix that includes stocks, bonds and cash, you may lower your risk by not being overexposed in any one area.

Invest regularly in good or bad markets. Invest often and you may benefit from lower prices when the market is down. Contribute regularly to a mutual fund through your 401(k) plan, for example, and you could get some bargains without even realizing it.

Don’t panic. Even the worst market crashes have rebounded eventually. Despite some notable drops, the Standard & Poor’s 500 Index, a popular measure of the larger stock market, has returned about 10% per year on average.* Stick with an investment strategy that keeps you in the market. And try to avoid emotional decisions in those downward Dow moments.

*Average annualized return of the Standard & Poor’s 500 Composite Index from 12/31/1927-08/31/2019 is 9.83% not including dividends. Past returns provide no guarantee of future results. Standard & Poor’s 500 Composite Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks. This index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or U.S. federal income taxes. Investors cannot invest directly in an index. Source: S&P Dow Jones Indices LLC.


 

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