The summer, and now autumn of 2011 has proven to be extremely volatile in the stock market, and in asset markets in general. Stocks, bonds, and commodities all have seen dramatic fluctuations, both up and down. Triple digit moves in the Dow (DJIA) that were once rare have lately been the norm. This type of volatility can be a boon to active traders, but it can be frightening, even downright dangerous for everyday “retail” investors.
Any novice investor will tell you that the key to successful investing is to buy low and sell high. Seems simple right, and in concept it is, but in practice it can be very difficult to actually accomplish. The emotion and psychology of the stock market can often be at odds with the psychology of self-preservation that is very much at play when people are making critical financial decisions. When investing, similar to other aspects of life, people tend to follow a herd mentality; generally selling in times of panic, when stocks prices have already fallen and are low, and buying in times of euphoria and hubris, when stock prices are elevated.
So what do you do? How do you preserve or attempt to grown your capital under these conditions? Well the first thing to do is to consider your situation, and be clear about your goals. What might be good advice for a younger investor with a higher risk appetite could be very poor advice for someone closer to retirement, with less ability to sustain potential losses.
Lets look at the two ends of the spectrum. For a younger investor with a longer-term investment horizon, high market volatility can be a good time to take action. High volatility almost always coincides with downward pressure on equity markets, which will at some point create good buying opportunities. Have a shopping list of stocks, do your research, and buy with discipline. Pick an entry point and begin to buy up a portion of the overall position that you want to hold long term. You should then continue to purchase on market dips until you have completed your position, if the market continues lower you will lower your average cost as you purchase the remainder of your position. If the market moves higher, your position will appreciate in value, albeit with fewer shares than you may have intended.
Once you have accumulated your position the toughest part may be to stand your ground. A given during times of high volatility is that the markets may well overshoot fair valuation, and continue down to levels that are irrationally low. If you still believe in the fundamentals of the companies in which you’ve invested, then the only thing to do is stand your ground. You have to be willing to accept the potential for a short-term loss on paper, knowing that in the long term you’ve made a wise purchase.
On the other end of the spectrum, what do you do if you have a low risk tolerance and you’re anxious because of market volatility? The best advice is to review your portfolio, and make sure that your asset allocation and risk stance is appropriate to your life situation. Especially if you haven’t rebalanced your portfolio recently, it may be time to carefully readjust. Although it may be a precarious time to be moving around your holdings it is an excellent time to seek the advice of an investment professional, and make certain that your portfolio matches your current needs. A good financial adviser will seek to understand your needs, and help you to develop a plan that aligns you asset allocation to your future needs given current economic conditions.
High market volatility, big moves up and big moves down are good at creating headlines, good at churning stomachs, but in general not very good at creating wealth for retail investors. Even for experienced investors, turbulent markets can cause serious heartbreak (consider all the hedge funds reporting staggering market losses for the past quarter). If you have dreams of being a hero, make sure you can afford the potential for loss. If you want to come through high market volatility without increasing your risk, talk to your financial professional, seek only the advice of the most level headed people you know, and remember that often the safest course is to sit tight and ride out the storm.