Market Volatility: Check Your Emotions at the Door
Surges and sags—that has been the nature of the stock market in 2018. Whether it's trade policy concerns, tax breaks, inflation fears, economic optimism or a recession watch, the stock market has reacted. Investors have been on a rollercoaster ride that raises the question: what should you do in times of volatile markets? In many situations, the answer is sit tight, and take the long view.
"One enduring truth about stock
markets is that they go up, and they
go down—and the steeper the rise
or the fall, the more tempting it can
be to derail a long-term strategy with
a snap decision."
"One enduring truth about stock markets is that they go up, and they go down—and the steeper the rise or the fall, the more tempting it can be to derail a long-term strategy with a snap decision," said Gerri Walsh, FINRA's Senior Vice President of Investor Education. "Especially when markets fall sharply, we tend to react on impulse. Before that becomes your reaction to market volatility, focus first on your goals and your investment timeframe."
Investors who need short-term liquidity—for example, if you plan to make a large purchase such as a house or a car, or you know a tuition bill is about to come due—will likely want to pursue a different path than investors who do not need cash right away. All else being equal, the latter group might be better able to stomach volatility in the short term. But any investor who cannot bear the thought of—or cannot afford—locking in losses in times of volatility may want to explore less volatile alternatives to help secure their portfolio's value.
"Talk to your investment professional," said Walsh. "And consider the broader consequences. How does any action you choose to take in the moment impact your portfolio in the future? What are the tax consequences? Before you make any decisions regarding your investments, it's important that you keep your emotions in check and understand what is going on."
Whether any given day's drop reflects a market correction, an anomaly or the beginning of a bear market can take time to figure out—and is outside the control of any one investor. So control what you can—and focus on key investing concepts such as staying diversified and rebalancing to stay aligned with your goals.
Stay Alert and Consider Your Risk Tolerance
That doesn't mean you should turn a blind eye to market fluctuations. Volatility can be an important measure of investment risk—both market-wide and for an individual stock. If a stock has a relatively large price range over a short time period, it is considered highly volatile and may expose you to increased risk of loss, especially if you sell for any reason when the price is down.
Though there are exceptions, growth stocks (companies whose earnings have increased at a faster rate than competitors, often in expanding industries) tend to be more volatile than value stocks (companies in well-established industries whose stock has been trading for many years and might be considered under-valued). In contrast, if the range of prices is relatively narrow over a short time period, a stock is considered less volatile and normally exposes you to less investment risk.
But reduced risk also means reduced potential for substantial short-term return since the stock price is unlikely to increase very much in that time frame.
The stocks of any given company might become more or less volatile over time. One example might be a newer stock that had formerly seen big price swings, but becomes less volatile as the company grows and establishes a track record. Another example might be a stock with a traditionally stable price that becomes extremely volatile following unfavorable or favorable news reports or business developments—like the obsolescence of a key product or service, or a shift in state or federal policy that lifts or sinks the industry—which trigger a rash of buying and selling.
A common measure of a stock's volatility relative to the broader market is known as the stock's beta. This number compares the movements of an individual security against those of a benchmark index, which is assigned a beta of 1. For example, a stock with a beta value of 1.2 has historically moved 120 percent for every 100 percent move in a benchmark index, such as the S&P 500. In other words, it is more volatile than the broader market index. On the other hand, a stock with a beta of .85 has historically been less volatile than the underlying index.
Whether you invest in the broad market through index funds or through more narrowly focused funds or individual stocks, it pays to understand the effect volatility can have on a portfolio. It will help you keep a cool head when the ride gets rough.
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