Keeping your cool can be hard to do when the market goes on one of its periodic roller-coaster rides. It’s useful to have strategies in place that prepare you both financially and psychologically to handle market volatility. Here are 11 ways to help keep yourself from making hasty decisions that could have a long-term impact on your ability to achieve your financial goals.
Have a game plan
Having predetermined guidelines that recognize the potential for turbulent times can help prevent emotion from dictating your decisions. You can use diversification to try to offset the risks of certain holdings with those of others. Diversification may not ensure a profit or guarantee against a loss, but it can help you understand and balance your risk in advance.
Know what you own and why you own it
When the market goes off the tracks, knowing why you originally made a specific investment can help you evaluate whether your reasons still hold, regardless of what the overall market is doing. Understanding how a specific holding fits in your portfolio also can help you consider whether a lower price might actually represent a buying opportunity.
Remember that everything is relative
Most of the variance in the returns of different portfolios can generally be attributed to their asset allocations. If you’ve got a well-diversified portfolio that includes multiple asset classes, it could be useful to compare its overall performance to relevant benchmarks. If you find that your investments are performing in line with those benchmarks, that realization might help you feel better about your overall strategy.
Even a diversified portfolio is no guarantee that you won’t suffer losses, of course. But diversification means that just because the S&P 500 might have dropped 10% or 20% doesn’t necessarily mean your overall portfolio is down by the same amount.
Tell yourself that this too shall pass
The financial markets are historically cyclical. Even if you wish you had sold at what turned out to be a market peak, or regret having sat out a buying opportunity, you may well get another chance at some point.
Be willing to learn from your mistakes
Anyone can look good during bull markets; smart investors are produced by the inevitable rough patches. Even the best investors aren’t right all the time. If an earlier choice now seems rash, sometimes the best strategy is to take a tax loss, learn from the experience, and apply the lesson to future decisions.
Consider playing defense
During volatile periods in the stock market, many investors reexamine their allocation to such defensive sectors as consumer staples or utilities (though like all stocks, those sectors involve their own risks, and are not necessarily immune from overall market movements). Dividends also can help cushion the impact of price swings.
Stay on course by continuing to save
Even if the value of your holdings fluctuates, regularly adding to an account designed for a long-term goal may cushion the emotional impact of market swings. If losses are offset even in part by new savings, your bottom-line number might not be quite so discouraging.
Use cash to help manage your mind-set
Cash can be the financial equivalent of taking deep breaths to relax. It can enhance your ability to make thoughtful decisions instead of impulsive ones. If you’ve established an appropriate asset allocation, you should have resources on hand to prevent having to sell stocks to meet ordinary expenses or, if you’ve used leverage, a margin call. Having a cash cushion coupled with a disciplined investing strategy can change your perspective on market volatility. Knowing that you’re positioned to take advantage of a downturn by picking up bargains may increase your ability to be patient.
Remember your road map
Solid asset allocation is the basis of sound investing. One of the reasons a diversified portfolio is so important is that strong performance of some investments may help offset poor performance by others. Even with an appropriate asset allocation, some parts of a portfolio may struggle at any given time. Timing the market can be challenging under the best of circumstances; wildly volatile markets can magnify the impact of making a wrong decision just as the market is about to move in an unexpected direction, either up or down. Make sure your asset allocation is appropriate before making drastic changes.
Look in the rear-view mirror
If you’re investing long term, sometimes it helps to take a look back and see how far you’ve come. If your portfolio is down this year, it can be easy to forget any progress you may already have made over the years.
Take it easy
If you feel you need to make changes in your portfolio, there are ways to do so short of a total makeover. You could test the waters by redirecting a small percentage of one asset class to another. You could put any new money into investments you feel are well-positioned for the future, but leave the rest as is.