How 3 Types of Investors Can React to Volatility

It's natural to worry about the value of your portfolio when the number is fluctuating wildly from one day to the next. But if you find yourself compelled to react, your asset allocation and risk tolerance may be out of sync.

Before you face such circumstances, ask yourself two questions:

Younger adults in their prime working years, for example, can afford to take on more risk since they likely won't need to tap their savings for decades. In a similar vein, some older folks have portfolios so large that even a significant downturn wouldn't undermine their ability to cover day-to-day expenses or leave a legacy to their heirs. "Both types of investors should be less sensitive to short-term volatility," Mark says.

Retirees who need to draw income from their portfolios, on the other hand, should walk a middle path: having enough liquidity to cover ongoing and emergency expenses without sacrificing the potential for long-term growth.

"We suggest keeping two to four years' worth of living expenses in cash or short-term investment-grade bonds, with the rest in a balanced mix of stocks and fixed income based on your time frame," says Kathy Jones, Schwab's chief fixed income strategist. "That way, you're not forced to sell investments at a loss to cover immediate expenses, but you're still positioned for potential growth over time."

How you allocate your assets should be based on three things: your short- and long-term goals, the number of years you have left to invest, and your risk tolerance.

Beyond the numbers, temperament also plays a role. "If you can't stomach the downside, even with a relatively long time horizon, it may be time to reassess your financial plan before you make moves that could prove counterproductive," says Liz Ann Sonders, Schwab's chief investment strategist. "Conversely, if you see volatility as a buying opportunity—which it can be—make sure your enthusiasm doesn't outpace your discipline."

With answers to those questions in mind, here's how to approach your portfolio now, depending on your risk tolerance.

If today's extreme uncertainty is making you queasy, you have options:

• Cash in your winnings: Taking some gains off the table locks in profits and can help reduce risk. "If you've ridden a hot stock most of the way up and still have a substantial profit, maybe it's time to trim that position and redeploy the funds elsewhere," says Nathan Peterson, director of derivatives analysis at Schwab. That said, be sure to factor in the potential for capital gains taxes if you're selling from a taxable account.
• Make some tax-smart moves: By the same token, harvesting losses in your nonretirement accounts can help to offset your gains and potentially lower your tax bill. If your losses are larger than your gains, you can offset up to $3,000 of ordinary income annually until the loss is fully accounted for.
• Play defense: One way to reduce risk is to shift to less volatile investments within an asset class, such as away from energy stocks and into utilities, or away from high-yield bonds and into U.S. Treasuries. This isn't about timing the market; it's about helping you ride out volatility with fewer jolts.
• Reassess your asset mix: A more aggressive step is to shift to a less risky asset allocation, such as reducing your stock exposure and increasing your bond allocation. "Some people will never be comfortable with a higher-risk portfolio, even if their risk capacity can tolerate the potential losses," Kathy says. "If that's you, that's OK. Just know that less risk generally means less reward, so you'll need to update your growth assumptions—and potentially increase your savings rate—to compensate."

Even if you're relatively comfortable with your current asset allocation, you should still take steps to keep your finances on track:

• Rebalance your portfolio: The S&P 500^® Index rose more than 23% in 2024, which means that stocks may make up more of your portfolio than you intended. "When left to our own devices, we tend to let our winners run and grow to an outsize proportion of our total portfolio," Liz Ann says. However, part of being a long-term, disciplined investor is rebalancing to your intended asset allocation whenever an asset class drifts too far from your target—for example, by five or more percentage points.

• Don't try to time the market: Even if you're sticking to your plan and continuing to save regularly, it can be tempting to try to time your entrances and exits to maximize your gains and minimize your losses. But that's generally a losing strategy: The market can turn on a dime, and missing just the top 10 days out of all the trading days over the past 20 years would have cut your annual returns nearly in half.

Missing just a handful of the best trading days can severely erode your returns.

• Consider other opinions: If you share assets with someone else, consider their views, as well. "One person may be willing to ride it out while the other may be ready to run for the hills," Mark says. "It's important to work through these emotions together and to bring in your advisor if you're struggling to find a middle ground."

Some investors subscribe to the maxim "Never let a good crisis go to waste." If you're one of them, be sure to establish some guardrails:

• Set a limit: When leaning into a volatile environment, you can reserve a certain amount of money for trading—and never at the expense of long-term savings. "Don't let the prospect of outsize profits distract you from your plan," Nathan says. "Volatility can supersize not just your profits but also your losses."
• Focus on quality: Unless you're an active trader, any moves you make now should still support your long-term portfolio. Look for companies with low levels of debt and consistent cash flows, both of which may help them weather economic head winds—and potentially outperform while others struggle.

• Be mindful when deciding to "average down": When a stock you own undergoes a meaningful pullback, it could be a buying opportunity—just make sure that you're still following your original investment thesis for buying the stock. Is a fundamental shift in the company or sector driving the sell-off, or is it just a temporary price dislocation due to a broader market correction? "Try to avoid averaging down solely as a means of lowering your overall cost basis and thereby feeling 'less wrong,'" Nathan says. "Averaging down can make sense at times, but you could also be throwing good money at a bad investment if it's an emotional reaction to a loss."

For those tempted to pull most or all of their money out of the market, Liz Ann offers a word of caution: Don't.

"Doing so locks in your losses and undermines your ability to participate in the recovery, which could happen at any time," she says. "By the time you're ready to get back in, you've likely missed some of the best days."