• Investing & Markets

When Market Conditions Become Volatile, How Will You React?

August 21, 2015 | Craig Birk, CFP®

As investors across the globe have seen, this week has been a volatile one in the downturned capital markets.

When markets move drastically, it’s important to remember a few basic investing principles. As you monitor your portfolio during volatile times, make sure to keep these important factors in mind:

Market Volatility Is Normal And It Is Important Not To Overreact.

It may feel like the market has had some especially big swings this year, but when you look at markets historically it hasn’t been as extreme as it may have felt.

So far, 2015 has been one of the flatter years on record, with the global stock market down 2.5% year to date. Usually, the US stock market declines in 1/3 of years. When US stock markets decline, the average drop is 14%. Volatility may feel concerning when you’re in the midst of it, but taking risk is also what drives wealth creation for stockowners.

At Personal Capital, we always stress how crucial patience and discipline are during volatile market times. If you’re an investor, you’re also a human, meaning that it’s not so easy to kick back and stay calm during downward volatility. Nobody likes to see the value of their portfolio decline. So if you have a financial advisor, the most important thing they can do for you in times like this is to help you avoid making rash portfolio changes, and stay the balanced long-term course.

A Diversified Portfolio Is The Best Way To Position For Whatever Comes Next.

Regardless of market conditions, diversification is key. When market conditions are volatile, it’s a great time to assess how well diversified your portfolio is, and make any changes needed.

When markets are good, confident predictions lead to mistakes that can derail your portfolio. You can’t control the markets, but you can take ownership of your investment strategy and asset allocation.

When stocks decline, your portfolio declines too. That’s why you diversify – to cushion against the blow of a decline like what we’ve seen in markets this week. If you’re invested in US Stocks, you’ve seen that the few hot stocks that were supporting the market have started to fall out of favor. On a relative basis, that bodes well for a more diversified sector and style approach. This approach has held up well over the course of the month, compared to capitalization weighted indexes.

We all know that markets go both up and down, and when they go up we’ll likely see substantial upside potential in a few battered and unloved sectors, like Emerging Markets Stocks and Bonds. Over the last several years (and especially the last 12 months) US Stocks have trounced all other major asset classes. That won’t last forever, and folks that stay diversified and rebalance periodically will reap the benefits.

Don’t Let Emotion Get The Best Of You.

Many experts suspect that signs of greater than expected weakness in China caused the recent market decline. While this could slow global growth, we aren’t predicting an imminent bear market (while that could still happen).

Troubles in China may get nasty, but we’re not worried about a 2008 Lehman type scenario for stocks. The sharp market plunge in 2008 resulted from a massive liquidity freeze where banks lost confidence in each other. In today’s case, western banks have very little exposure to China. Oil, commodities and emerging markets currencies are at risk, but they have already been hit hard and can only fall so far.

It’s normal for investors to be nervous during volatile markets, especially given how long it’s been since we’ve experienced a meaningful decline. We encourage investors not to succumb to the stress of a volatile market by bailing out or chasing the latest asset class that is doing well. If you do, you’ll likely be worse off.

As a rule of thumb, focus on a global, multi-asset class portfolio strategy, to deliver superior risk adjusted returns over time. And when the markets take a dip, remember the importance of a long-term plan that will ultimately provide the financial returns you need.

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