This is a sponsored post from Fidelity Canada.
As an investor, learning to handle the ups and downs of your portfolio is a skill in itself. This is especially true if you have to stomach extended periods of market downturn or significant volatility.
However, there are strategies investors can use to make periods of high volatility easier to manage mentally and in terms of risk. And depending on your investing goals and life stage, some of these strategies can help protect your nest egg for retirement.
What Is Market Volatility?
Market volatility is a statistical measure of how often a particular market, asset class, or security rises or falls in price. In extremely volatile markets, large price swings are more common. Additionally, market volatility is often associated with high downward price changes - not the sort of news most investors are happy with.
Market volatility can also occur for many other reasons, including:
● Climate disasters or changes
● Major industry changes, disruptions, or regulations
● Political and economic factors
● Social sentiment being overly positive or negative
● Technological advancement
Volatility is also an inevitable part of investing. And if you’re investing for the long term, you can usually ride out periods of market uncertainty or a few bad years.
However, it’s also important to protect your portfolio from unnecessary risks, especially if you’re closer to retiring. That’s why learning how to look at investing during periods of volatility is a skill every investor should have.
Strategies and Perspectives for Investing in Volatile Markets
If you’re trying to reduce the impact of market volatility on your portfolio, the following strategies are worth adding to your investing toolkit.
1. Take A Long-Term Investing Approach
As mentioned, one of the most common approaches to investing during periods of volatility, particularly for investors not nearing retirement, is to simply ignore the current market by taking a long-term view.
This investing philosophy is largely based on historical performance data. For example, the S&P 500 has returned around 10.3% on average since 1926. This includes dreadful years and stellar years of performance. But when you compare the average rate of return versus inflation, long-term investors who believe in the market generally end up ahead even with some awful years.
This can have a great impact if you’re a newer investor and have a longer investment horizon. After all, if you have potentially decades ahead to invest, a few volatile years can easily be offset with time and compound interest.
2. Diversify Your Portfolio
Another way a smart investor can manage volatile markets is to diversify their portfolio. Instead of putting all your eggs (investments) in one basket, diversification can help you reduce the potential impact of volatility on your portfolio by investing in multiple asset classes and risk levels.
The idea is to invest in more diversified baskets of companies with mutual funds and ETFs. If you’re nearing retirement, this is also a wise move since you can better protect your nest egg from a few bad months of performance.
Just note that during periods of high inflation, fixed-income investments like bonds and GICs are less enticing. This is because the low returns often don’t outpace the inflation rate. In this case, options like mutual funds series that don’t pay a trailing commission or broad ETFs can potentially offer higher returns and increased diversification versus individual stocks.
3. Rebalance Your Portfolio
One common impact of market volatility on your portfolio is that your portfolio’s composition changes dramatically.
For example, let’s say you’re investing in numerous stocks, some ETFs, and bonds. If market volatility causes one asset allocation to sharply rise or fall, your portfolio composition might become very different from your original goal.
Portfolio change is inevitable with investing. This is why many investors rebalance their portfolios quarterly or annually. Rebalancing involves selling off positions that have grown and outweigh the rest of your portfolio and reinvesting the profits into other asset classes. This could mean selling off some stock winners and putting more money into mutual funds and bonds for added diversification and fixed income.
4. Consider Dollar-Cost Averaging
Many investors’ initial reaction to market volatility is to stop investing and hold cash. This isn’t always a bad idea, especially if you’re following markets carefully and are actively looking for buying opportunities.
However, sitting on the sideline out of fear isn’t necessarily doing you any favours. Canada saw a 3.4% annual inflation rate in 2021, with inflation only increasing in early 2022. This means holding your money in a basic savings account or under your mattress is a surefire way to lose value on your capital.
To avoid inactivity, you can consider dollar-cost averaging. This strategy involves regularly investing a predetermined amount of money into the market regardless of current prices. Ultimately, this helps offset volatility since you end up buying assets at low and high prices. You also eliminate the risk of timing a lump-sum investment poorly.
Finally, because many investors don’t like to invest more (or at all) when the market is down, it’s difficult behaviorally to go against the trend or what feels like the prevailing mindset at the time. Dollar-cost averaging by investing a fixed amount at predetermined intervals also helps reduce the emotional rollercoaster of deciding whether or when to invest.
5. Keep Some Cash on Hand
Dollar-cost averaging can help reduce the impact of market volatility on your portfolio. But this strategy doesn’t mean you can’t time the market as well.
Keeping some cash on hand during periods of high volatility lets you react to opportunities quickly. So, consider dollar-cost averaging the bulk of your investing capital. But don’t be afraid to keep some cash in reserves in case an asset class you’re interested in tanks.
This strategy isn’t useful for passive investors who don’t follow the market. But if you have some companies or funds on your watchlist, consider keeping a bit of money on the sideline so it’s ready to deploy.
6. Don’t React Emotionally
One final strategy for investing in volatile markets is to not react emotionally.
This is easier said than done. After all, waking up to an all-red trading screen on your online broker isn’t easy. And it gets even harder if you’re down 10% to 30% and it’s been months of a bear market.
However, investors should react to market volatility by reflecting on their investing goals and philosophy, not their emotions. This means evaluating your risk tolerance and determining if your current holdings match that tolerance. If you’re a long-term investor, it’s important to avoid knee-jerk reactions to poor performance and focus on the bigger picture.
Volatility is generally an inevitable aspect of investing. However, this doesn’t mean investors are helpless. Active strategies like portfolio diversification and rebalancing let you react to volatility risks quickly. Overarching strategies like dollar-cost averaging and long-term investing help keep you on the right path even when the going gets tough.
Ultimately, the strategies you use to boil down to your overall financial goals, timeframe, and risk tolerance. So, clearly outline these three metrics so you know what type of investor you are. That way, when market volatility ramps up, you can keep a cool head and stick to your investing philosophy.
Commissions, trailing commissions, management fees, brokerage fees and expenses may be associated with investments in mutual funds and ETFs. Please read the mutual fund or ETF’s prospectus, which contains detailed investment information, before investing. Mutual funds and ETFs are not guaranteed. Their values change frequently, and investors may experience a gain or a loss. Past performance may not be repeated.
The statements contained herein are based on information believed to be reliable and are provided for information purposes only. Where such information is based in whole or in part on information provided by third parties, we cannot guarantee that it is accurate, complete or current at all times. It does not provide investment, tax or legal advice, and is not an offer or solicitation to buy. Graphs and charts are used for illustrative purposes only and do not reflect future values or returns on investment of any fund or portfolio. Particular investment strategies should be evaluated according to an investor’s investment objectives and tolerance for risk. Fidelity Investments Canada ULC and its affiliates and related entities are not liable for any errors or omissions in the information or for any loss or damage suffered.
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