Bouts of 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.
Yet it’s hard to sit still when the market is sliding. You can’t help but think: “Shouldn’t I be doing something?” Every investor is different, but here are a few steps that everyone should consider.
During market volatility:
1. Resist the urge to sell based solely on recent market 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.
2. Adapt your trading to fast-moving markets. If you must trade during volatile markets, take current conditions into account when entering orders. 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.1 These can help give you more confidence when markets are volatile.
3. 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, but all investors would do well to ignore the noise and stay focused on their plans.
4. Review your risk tolerance. Some investors learn the hard way that they aren’t as willing to face a sharp drop in the value of their portfolios as they had assumed. Similarly, risk you took on years ago may no longer make sense given your current situation and life stage. An aggressive allocation has historically gained more over time, but at the price of greater volatility—which can be especially risky if you don’t have much time to recover. Market downturns sometimes can be a wake-up call to consider adjusting your target asset allocation of the level of risk in your portfolio doesn’t match your situation.
5. 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. Schwab’s investor profile questionnaire can help you determine your profile and match it to an appropriate target asset allocation. If you need more help, call 800-355-2162 to be connected to a Schwab investment professional.
6. 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 hold those funds 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.
7. 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.
1 There is no guarantee that execution of a stop order will be at or near the stop price.