What You Need to Know About Market Volatility

What is market volatility, and how should your stock market strategies shift in a volatile market? Market volatility refers to swings in economic performance that can affect the value of your portfolio or retirement account. A market is volatile if it’s often going up and down. And for some investors, that can be nerve-wracking.

But here’s what you should remember when you’re thinking about investing in volatile markets: it’s all about the long game. Market volatility and swings in economic performance are normal. Between 1945 and 2022, the S&P 500 declined between 5 percent and 10 percent a total of 84 times. While that can feel frightening in the moment, history shows that a level hand is in order. The average portfolio recovered in just a month. Historically speaking, a bigger market drop happens every 5 to 10 years. But there’s good news: There’s never been a dip from which the market hasn’t recovered.

Still, fears of a market on the brink are enough to ruin any investor’s sleep. Read on to learn about what market volatility looks like along with smart stock market volatility strategies.

Why Market Volatility Happens

The cause of market volatility often comes from outside the market itself. Worries about trade wars, political uncertainty and economic data can all kickstart a market drop. Sometimes the cause is an overvalued sector (such as tech stocks in 2000) or a crisis (like the housing market meltdown of 2007). Furthermore, national and international emergencies including earthquakes, terrorism attacks, pandemics and wars have all touched off plunges. It’s the market’s way of trying to adjust for what might happen — and often it’s a bit of a guessing game.

How to Prepare for Volatility

Diversification is key to facing a volatile market with confidence. The more types of investments you have, the less devastating any one single downturn can be to your overall value. In addition to U.S. stocks and bonds, there are other types of investments to look into. You may want to diversify your stocks and invest in international stocks, which often don’t follow the same trajectory as domestic stocks. Also take a look at additional investments such as real estate, venture capital (which funds startups with long-term growth potential) and commodities like gold.

Have a Cash Reserve

In a bear market, when stock values drop by 20 percent or more, you’ll want to have enough cash to cover major expenses for the next couple of years. Even if you’re earning a salary, your cash reserve should cover big-ticket items such as school tuition and major home improvements. High-interest savings accounts, certificates of deposit (CDs) and short-term bonds are all good places to stockpile cash so you don’t need to pull money out of your portfolio when prices are reduced, which also lowers the value of your investment.

Know When to Tweak

A market downturn is a bad time to sell assets in your portfolio, because you’re turning potential loss into real loss. Instead, this may be a good time to buy if you have extra money to invest; stock prices are low, so you have a high likelihood of making money when the market recovers. 

If you’re approaching retirement and volatility caused concern, review your risk tolerance with your financial advisor once the market has recovered. In general, people who are closer to retirement transition their money to less risky investments and ensure they have enough liquid assets to cover living expenses for a few years. That way they won’t be forced to sell during a downturn and take a loss on their retirement nest egg. 

Ride It Out

Volatility generally passes within weeks or months. In a worst-case scenario, market volatility should pass in a couple of years. Even after the 2008 downturn, when the S&P 500 plunged 56 percent, it took the market up to three years to recover. The initial outbreak of the COVID-19 pandemic caused a 34% drop, but the market was back to its February 2020 level in approximately 26 weeks. Though we have experienced continued volatility since then, there’s been light at the end of every tunnel. And with diversified investments and some patience, you’ll be just fine, too.

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