The stock market is not a straight ride up as we would all like, it swings up and down, sometimes widely, so that’s why you need to learn tips for investing in a volatile market.
I’m sure you’ve experienced a stock market crash at some point or at least stock market volatility.
For example, COVID-19 has caused the stock market to crash by over 20% in February and March of 2020.
Then the market experienced a 13% rebound in April!
Volatility in the stock market can be very worrisome to investors. Unfortunately, many of those investors will panic and sell their equity positions.
When these positions are sold the losses are realized instead of being just paper losses. They also transfer their investments to safer investments which reduces their ability to regain their losses.
Every investor has one of two goals. First, they are aiming to increase their portfolio for a goal such as retirement, college, or something even like a vacation. The second goal is to preserve their purchasing power by investing their money to keep up with inflation.
Let’s get into the tips on how to deal with investing in a volatile market…
Investing In A Volatile Market
Volatile markets are scary, nobody likes seeing their portfolio dip 20% then go back up 10% then dip another 15%.
The worst thing you can do when the market takes a big dip is to panic and sell! Doing this causes investors to lose a lot of money.
For example, between October 2017 and March 2018 Fidelity Investments reported that those with 401ks who sold during the volatile only regained about 2% of their losses by June of 2019. Those who were still invested regained more than 50% of their losses comparatively.
Let’s look at another example, the volatility in 2020, and see what would happen if someone panicked and sold in March 2020. Both investors had $100k to start the year off.
As you can see from the chart above that our steady investor was down $20k but recovered $10k thanks to the rally in April. The panicked seller is still down $20k from selling their position in March.
There could be an argument that if you sold in February you would be in a better position than the steady investor in April. While that is true, it is never recommended to try to time the market!
During times like this, most investment firms and wealth managers try to encourage clients to stay invested rather than take losses as riding out volatility in the market in the long term is a proven investment strategy.
In 2019, the market had an incredible bull run. At the beginning of 2020 before the big losses, you could have taken some 2020 losses but been up due to the 2019 gains.
If you need the money soon or wanted to preserve your retirement. It could have been an option to switch investments.
Everyone’s situation is different but staying invested is usually the right answer 90% of the time.
Investment Strategy During Volatility
You should always have an investment strategy, especially during volatile market conditions. Not having one is probably the worst strategy you could have.
Personally, my strategy is to buy into companies that are trading at a fair valuation and have at least moderate growth with a dividend.
The investments I choose are long-term investments that I am willing to hold onto for a minimum of 5 years.
I have built different tools to help me research and decide on investments which helps me build confidence that I am making the correct decision.
Without a strategy, I could fall victim to emotions such as selling at the bottom or having a fear of missing out and buying at the top.
My strategy might not work for you, it all depends on your situation and the investments you hold.
If you are invested in index funds, ETFs, or stable companies then it’s best to ride out the downtrend because your investments will most likely pick back up over time.
However, if you are invested in riskier companies that have high debt and low earnings then an economic downturn can be devastating for the company so it might be smart to sell now for a loss rather than lose more down the line.
You have to determine what’s right for you in the specific situation and it might be best to consult with a financial advisor if you are not sure what option to take.
Getting Into The Right Mindset
Investing in a volatile market comes down to one powerful tip, get into the right mindset.
Volatile markets affect everyone, yet some investors remain calm and ride it out while others panic and sell their investments for big losses.
Why is this? It’s due to the mindset of the investor. Some investors think with reason and rationality while others make decisions based on emotions.
Never let emotions control your decisions, this is a big mistake that will have drastic effects on your finances!
So, how do you get into a mindset to be able to ignore the noise of the market?
Well, this ties back into your investment strategy. If you have a solid investment strategy and make your investments based on research then you shouldn’t have anything to worry about.
I have a few simple rules to help me manage my investments…
For my 401k, I use my #1 rule of don’t touch my 401k. I like my investments which are well diversified and I just let them run on autopilot. I only review it maybe 2-3 times a year.
For my investment accounts, I carefully pick the companies I invest in and rely on my investment strategy. I only invest in companies I know will be around for many years to come, I don’t invest in speculative or trending stocks.
However, even the greatest investors make mistakes and I definitely had my fair share of mistakes when it comes to investing.
When I first started investing one of the first companies I bought was UPS. It is a well-run company and I was excited.
A month or two later I sold the stock after an article announced Amazon was building its own fleet and would kill UPS deliveries. I lost 15% of my investment. A week later UPS bounced back to my original purchase price.
I was panicking and did not follow my strategy, which I did not fully have developed at that point. I should have realized that while UPS moves a lot of Amazon packages, Amazon packages are not very profitable.
The core business of shipping other items is much more profitable and meaningful for their business which is why FedEx stopped delivering Amazon packages.
So, the key is to not panic and make decisions based on fundamentals. If you do make mistakes, which might happen, learn from them and move on.
Conquer The Fear of Volatility
Volatility in the market causes a lot of fear in investors and it’s due to one specific reason, not wanting to lose money.
Of course, right! No one wants to lose money but panic selling to minimize losses might cause you to lose money when you should have stayed invested to recoup your losses or even make a profit.
We talked about using an investment strategy to help with volatility but there are other things you can do too! One thing is to have some buffer by having cash reserves.
That cash buffer is actually good for two things. First, you should not have all your money tied up in investments.
If you need money then you might be forced to sell at a bad time realizing a loss. Second, a buffer could also help you buy stocks during volatility to help reduce your cost basis on your investment.
The next one actually ties into your investment strategy. Your investment mix should accurately reflect your risk tolerance and time frame.
If you are opposed to risk having a more bond-heavy portfolio might be better than equity positions. Additionally, having an index rather than a specific company could also help.
There are tons of options to choose from so just research the best mix for you.
When you do have the right investment mix, just keep in mind that you will probably have to re-balance your portfolio as not all investments grow at the same pace.
You may have to transfer gains from riskier investments to less risky ones to prepare for volatile times by ensuring a balanced investment.
Making Money In A Volatile Market
When a market downtrend happens most people are just figuring out ways to prevent losses but these times also present great buying opportunities!
This is why having a cash reserve is so important, you should have an emergency fund so you don’t have to sell stocks when they are down and you should also have some extra cash for buying opportunities in the market.
Certain companies might die out in an economic downturn but big-stable companies and the market as a whole are likely to rebound.
This means that you should stay invested and even invest more if you can!
A great strategy to use is dollar-cost-averaging, which is just consistently investing a set amount of money every month, week, etc…
Simply, if you have the cash available, you should take advantage of market downturns by investing more to make more profit.
Using Options For Hedging
This is a really exciting way to hedge some risk but it is also something I am not that experienced in. I have been researching this myself and playing around with some online market simulators.
I highly recommend trying new strategies out with fake money first!
So in theory this is how options can help you hedge some risk. The first option is simpler.
You can buy a put option which basically gives you the right to sell your stock at a predetermined price. An option is sold in increments of 100 shares just as an FYI.
For the ability(option) to sell the stock at a determined price, you have to pay contract costs to the potential buyer, who would be the seller of a put option.
This is a good strategy to protect you from downside risk as option contracts are not that expensive.
The second way to use options would be selling covered calls. You sell the option and collect money from a buyer, in exchange for a promise to sell your stock if it reaches a specified price (higher than it trades at the time of contract).
The option must hit the price target (strike price) within a predetermined time frame (expiration date).
If it does not hit that predetermined price then the contract expires and you keep the money from the option contract.
Now you have the best tips for investing in a volatile market!
You should maintain your conviction and stay with your investment strategy. If the companies you invested in are strong (growing revenue, profits, dividend) but the market is declining just hold fast!
If you know your emotions will get the better of you then please speak with your investment team or wealth advisor!
An investment professional can help be a voice of reason during volatile times. That guidance might reduce your anxiety.
The more experience you have and the time invested will help you look longer-term rather than at the choppy short term.
Do you have any tips for investing in a volatile market? What do you do when the market is experiencing volatility? Let me know in the comments below!