If you have never invested your hard-earned money before, now might seem like an intimidating time to start. After all, dramatic shifts in the markets (known as volatility) can be scary—even for the most experienced investors. The good news is that volatility has the potential to create profitable opportunities.
What is Volatility?
In simple terms, volatility is the relative rate at which the price of a security goes up and down. If the price moves rapidly over short time periods, it has high volatility. If the price almost never changes, it has low volatility. To keep markets swings from making you uneasy, take steps to help you respond to volatility in a deliberate way.
1. Stick to your plan.
Although your instincts might compel you to act quickly (panic selling and/or euphoric buying) in the face of market volatility, just remember that such impulsive trading can, and usually will, be detrimental to your long-term results. Although it’s human nature to want to “get out” when things look bad, choosing to stay invested during a market downturn can sometimes be the best course of action, if you’re confident in your strategy. Try not to dwell on short-term performance.
2. Buy when the stock market is “on sale.”
Human behavior and stock prices will always be more erratic than actual changes in fundamental business values. Emotions tend to determine stock prices in the short run, leaving some companies temporarily mispriced. During periods of extreme volatility, it is often easier to find businesses that are undervalued by the market. As prices fluctuate, take advantage of the volatility by purchasing or adding to your favorite names as they become cheaper (and trimming those that become more expensive).
Diversification simply means investing in a variety of assets, with the hope that positive performance of some investments will neutralize any negative performance in others. The goal of diversifying is to limit the risks associated with “putting all your eggs in one basket.” Most retail investors have a limited investment budget, making it difficult for them to put together a diversified portfolio on their own. Buying shares of a mutual fund can provide a readily available source of diversification.
4. Consider dollar cost averaging.
Purchasing a specific dollar amount in a particular investment at regular intervals (rather than purchasing a lump sum at once) can help take the guess work out of when to invest. It can also help reduce your exposure to the possible risks associated with making a single large purchase.
5. Review your overall tax picture.
For most individuals, capital losses can be used to offset capital gains in other areas. If a market decline leaves you with investments that are in a capital loss position, consult your tax advisor to determine if it would be beneficial for you to sell and use the proceeds to fund other investment opportunities.
All investments are subject to risk, including the possible loss of the money you invest. Past performance does not guarantee future results. There is no guarantee that any particular asset allocation, or mix of funds, or any particular mutual fund, will meet your investment objectives or provide you with a given level of income.