Beginner’s Guide to Market Volatility

Investors are usually 'better off buying than bailing' when markets are choppy, says chief strategist

"Meaningful declines, meaning declines of 5% or more, have happened, on average, every 104 calendar days."

Share
Getty Images

"Keep calm and carry on" isn't just fodder for vintage posters. It's also useful advice to remember when a volatile stock market takes a bite out of your investments.

When you see big red numbers on your portfolio page, your first instinct might be to panic and sell your biggest losers. But if you take a moment to step back and put short-term declines into the context of both market history and your goals as an investor, you may realize that it could be wise to move in the opposite direction.

"Knowing market history is like virtual Valium," says Sam Stovall, chief investment strategist at CFRA. "Understand how quickly the market tends to get back to break-even. Typically, investors are better off buying than bailing."

Read on for how investing experts suggest investors cope with short-term bouts of market volatility.

Put recent performance into perspective

While the circumstances that lead to precipitous drops in stock prices can feel unique, pullbacks themselves aren't at all uncommon, says Stovall. "Meaningful declines, meaning declines of 5% or more, have happened, on average, every 104 calendar days," he says.

Investors can take heart in how fast the market typically recovers, he adds. "For pullbacks between 5% and 10%, the market has gotten back to breakeven in 1½ months, on average," he says. "Among declines of 10% to 20%, the average is only 4 months."

In other words, he says, "by the time you convince yourself to finally sell, the market may be getting ready to bottom."

Down markets can be 'buying opportunities' for long term investors

Another important way to contextualize market downturns is by considering the broader picture of your investing goals. If you're a young person investing for retirement, you're decades away from needing that money.

Even if shakiness in stock prices turns into a full-fledged bear market, it would have to last more than five years to eclipse the longest bear on record. Given the stock market's historical upward trajectory, bear markets have been relative bumps in the road for buy-and-hold investors.

VIDEO1:0501:05
Suze Orman: Why volatility can be good for investors

Video by Helen Zhao

To that end, it's worth viewing a down market as an opportunity to buy investments at a discount, says Christine Benz, director of personal finance and retirement planning at Morningstar.

"For people whose main goal is retirement, if they're 20 or 30 years out, they should think of these periods as buying opportunities," she says. "Think about increasing your savings rate, if you can."

Benz isn't recommending dumping the balance of your bank account into the market once the numbers get low enough for your liking. Markets go up and down, and it's impossible for anyone, even the pros, to perfectly time or predict their movements.

Invest at consistent intervals whether the markets are headed up or down, Benz advises, a strategy known as dollar-cost averaging. Better yet, she suggests, set your accounts to automatically invest on your behalf.

"The beauty of automatic investment is not having to think about these inflection points," she says.

Certain investors can make some adjustments

If you're exclusively saving for long-term goals, you have your investments on autopilot, and you haven't once had the temptation to look at your holdings during the downturn, great. You're doing fine. For other folks, now might be a good time to make some tweaks, experts say.

For one, if you're saving for an intermediate-term goal, it may make sense to adjust your allocation to make it a little more conservative if you're concerned about market choppiness, Benz suggests. "If you're saving for, say, a home down payment, that might be a portfolio that you want to de-risk," she says. "That might mean adjusting your equity allocation down."

VIDEO5:0505:05
How cognitive bias affects your investments

Video by Courtney Stith

And even if you're a long-term investor, it may be time to do some reflection, says Stovall. "Take your own pulse. [Say the market] is down 10% on an intraday basis, which is nothing compared to deeper corrections, bear markets, and meltdown bears," he says. "If you have a tough time handling a 10% decline, how do you think you'll react to a 20%, 30%, or 40% drop?"

If the answer is something along the lines of, "I would lie away at night tossing and turning," it may be time to invest in a less volatile portfolio.

That can mean shifting some of your assets to dividend-paying, blue chip stocks, rather than fast-growing tech firms, for instance. Or maybe it means giving up on your crypto investment if the ride is too bumpy and you don't believe in its long-term potential.

You can also take a moment during rough markets to recalibrate your portfolio to the risk settings you laid out when you first began investing, Stovall suggests. "You can always hit rebalance," he says. "That way, you're buying low because stock prices have come down. But you're also selling high because you're trimming your cash or bond positions that went up or stayed steady when stocks went down."

Investing involves risk including the loss of principal. The views expressed are generalized and may not be appropriate for all investors.  Carefully consider your financial situation, including investment objective, time horizon, risk tolerance and fees prior to making any investment.

More from Grow: