Learn how to better prepare your portfolio for a downturn – and how to potentially take advantage of one when it occurs.
Market volatility is an inevitable part of investing. And, understandably, tumultuous times will likely trigger emotional responses to match.
But it’s important to take a deep breath, focus on your long-term financial plan, and consult with a trusted professional, one who has seen an unpredictable market or two and the subsequent recoveries.
Proactively diversify
Your first defense against volatility is crafting and maintaining a balanced portfolio. Effective asset allocation and diversification can broaden your reach in the market and potentially reduce your risk during periods of turbulence.
Volatility often affects individual sectors and asset classes differently, so diversifying across various classes, sectors and securities reduces the chance of one narrow decline devastating your overall portfolio. Additionally, paying attention to how your assets are correlated – how much they tend to move in the same direction – may help insulate your returns from the negative effects of volatility.
While diversification and asset allocation don’t assure a profit or protect against loss in declining markets, they do provide the opportunity to reduce risk, temper volatility and enhance risk-adjusted returns.
Consider:
- Your advisor can help you determine your long-term risk tolerance.
- Balanced portfolios may help reduce overall risk.
- Diversification may smooth ups and downs to help ease stress.
- Diversify across asset classes, sectors and securities.
- A broad portfolio offers the potential for better risk-adjusted returns.
The best-performing asset class often changes from year to year, and the difference between the best- and worst-performing in any year can be significant. Here’s a look at how major asset classes performed compared to a diversified, blended portfolio in each of the last 10 years.
Look for strategic opportunities
Market volatility isn’t always bad news. Though it may be tempting to concentrate on losses caused by price fluctuations, it’s important to remember that volatility, as well as changing price trends, may offer opportunities for gains.
One way to potentially use volatility to your advantage is through dollar-cost averaging, the practice of investing a set amount every month or quarter. Although engaging the strategy takes discipline – you’ll be putting money into the market when the headlines (and likely your friends and colleagues) are full of doom and gloom – price declines may afford investors the opportunity to purchase assets at better valuations. In fact, you may be practicing one form of dollar-cost averaging already by making regular contributions to a company 401(k) plan, perhaps biweekly or monthly.
It’s also good to keep in mind that, in the right situation, selling assets at a loss, a practice called tax loss harvesting, may prove beneficial. This strategy can help offset the taxes on your investment gains. At the same time, you free up capital to reinvest in the market.
Focus on the long term
Finally, don’t underestimate the value of time. The markets have proven remarkably resilient over the long term. While the financial markets can be quite volatile year to year, historically returns have been generally positive over multiyear periods. By simply staying invested, you may give your assets the chance to rebound in the wake of downturns.
Though it may be difficult, staying true to a personalized, long-term financial plan can help you achieve your long-term objectives. Your financial advisor can serve as a trusted guide, addressing any concerns and helping you make progress toward your goals.
Past performance may not be indicative of future results. Asset allocation and diversification do not guarantee a profit nor protect against loss. There is no assurance any investment strategy will be successful. Investing involves risk, including the possible loss of capital. Dollar-cost averaging does not assure a profit and does not protect against loss. It involves continuous investment regardless of fluctuating price levels of such securities. Investors should consider their financial ability to continue purchases through periods of low price levels.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our full schedule of upcoming CE-approved virtual events.
More Direct Indexing Topics >
