Most investors know that the market goes through times when it goes up and times when it goes down. So, what happens when the market is extremely volatile? If you make the wrong moves, you could lose everything you’ve gained and more.
Traders may be able to protect their assets from possible losses and make money from rising volatility by using either non-directional or probability-based trading methods.
VOLATILITY VS. RISK
Before choosing an investment strategy, it’s important to know the difference between volatility and risk. Volatility in the financial markets is a way to measure how fast and how much the price of an asset changes. Any asset whose market price changes over time is at least a little bit volatile. The swings are bigger and happen more often when volatility is high.
On the other hand, risk is the chance that an investment could lose some or all of its value. There are many kinds of risks that could lead to a loss, such as market risk (i.e., that prices will move against you).
As the market gets more volatile, market risk tends to go up as well. In response, there can be a big increase in the number of trades during these times, and the length of time that positions are held can go down. Also, when the market is very volatile, prices often overreact to news because people are too sensitive to it.
So, more volatility can lead to downswings that are bigger and happen more often, which is a risk for investors. Volatility can be reduced in some ways, which is good news. Also, there are ways to directly make money when volatility goes up.
“Market volatility is when the prices on financial markets change. When there is more volatility, there is a greater chance of both gains and losses.”
When you invest, market volatility is just part of the game. The market goes up some days and down other days. It’s normal to feel worried when the market drops, but if you’re ready for market volatility, you won’t make decisions out of fear.
The two best ways to get ready for volatility are:
- Spread out your investments.
- Set up a fund for emergencies
Diversification reduces the risk in your portfolio by spreading it out. A diversified portfolio may not gain as much as some single assets, but it probably won’t lose as much as others.
An emergency fund is a safety net for your money. If market volatility hurts your investments, you can use your emergency fund to pay your bills until the economy gets better.
We suggest that you don’t change your investments when the market is down. Give your investments time to get back on track. But if you can’t do that, try to make only small changes, like lowering your stock allocation to match a lower risk tolerance level. In general, you should invest for the long term, but you’ll probably also want a diversified portfolio that you can hold onto even when the market is bad. This can make it more likely that you’ll still be in the market when it recovers and gets back on track for long-term growth.
Still have the urge to do something? If you have a mutual fund, high management fees or capital gains distributions could make the market’s volatility feel worse. Or, your financial advisor might not stick to your target allocation as your portfolio makes and loses money. In these situations, a robo-advisor with lower fees, like Tenjin AI, can help ease the stress.
IN THIS USER GUIDE, WE’LL TALK ABOUT:
- How the market moves up and down
- Getting ready for it
- How to handle it
“No one likes it when their money gets worse. But in a volatile market, dips happen often.”
Market volatility is when the prices of investments go up and down. Some markets change more than others, like the stock market. And when the economy is in trouble, markets tend to be even more up and down, so you could see some big changes.
During dips, it can be tempting to sell everything and get out, but that usually does more harm than good. You could lock in losses by selling your assets before they have a chance to recover from a dip, and it’s hard to know when the market will be high or low.
If you move to cash when the market goes down, it’s like selling your clothes because you put on a few pounds. Even though they might feel a little tight, you could end up with nothing to wear if your weight goes the other way.
The stock market has had many bad days in the past. In any given decade, there will be a lot of drawdowns, which are times when the value of an investment drops to a very low point. But when you look at the market as a whole, it has been going up over time. So far, the global stock market and, by extension, the U.S. stock market have always recovered from economic downturns. Even though nothing is certain in life, those are pretty good odds.
History shows that sometimes you have to lose money in the short term to make money in the long term.
Investors should expect the market to be volatile. It has to happen. And that means you have to get ready for it instead of just reacting to it.
HOW TO GET READY FOR MARKET CHANGES
Volatility in the market can happen at any time. So you need to be ready for it now and in the future. The best thing you can do to get ready is to spread out your investments. When you have a mix of different assets, your overall level of risk goes down. Some of your assets may be struggling at the moment, but others may stay the same or even grow. The goal is for your portfolio to feel less like a roller coaster and more like a fun hike up wealth mountain.
After that, you should really think about starting an emergency fund. A good place to start is to have enough money to cover your bills for three to six months. Put it in a Cash Reserve account or set up a Safety Net goal with us. This lowers the risk compared to longer-term investments while also giving you enough potential upside to counteract inflation over time. This is money you want to have on hand in case the market goes downhill.
Major economic downturns can affect your life in other ways, even if you don’t depend on your investments for income. The bad economy could lead to layoffs, bankruptcies, and other things that could affect your ability to keep your job. Or, if you own rental properties, the real estate market could also be hurt. Even more reason to have an emergency fund so you can get through rough times if they come up.
WHAT INVESTORS SHOULD DO WHEN THE MARKET GOES DOWN
Stuck in a bad time? Don’t worry. When things look bad on the market, the best thing to do is usually nothing. It’s a common mistake for investors to sell off their holdings to stop further losses. This does two things:
IT SETS THOSE LOSSES IN STONE.
It means you can’t bounce back with the market.
Most of the time, scratching an itch won’t stop it from happening again. When you react to short-term losses in your portfolio, it’s the same thing. You want to fight the urge to act as much as you can.
Still, you may feel like you need to make a change from time to time. If that’s you, the first thing to do is make sure you’re okay with the level of risk you’re taking. Some types of assets, like stocks, are riskier than others. The more of your portfolio is made up of these assets, the more changes in the market can hurt you. You’ll also want to make sure that your time horizon (when you need the money) is still right.
Think of this like taking a few deep breaths or taking your pulse. You make sure that your investments look good and that everything works the way it should.
If you’re still tempted to do something drastic like sell all your investments, you might want to lower the amount of risk you’re taking. Even if everything seems to be going in the right direction for your goals, making a small change now could help you avoid making a bigger mistake out of panic later. Your heart rate is too fast. You breathe too quickly. Sitting at 90% stocks and 10% bonds? You could try putting 75 percent in stocks and 25 percent in bonds.
Depending on your situation, you might also be able to move your investments to a bank like Tenjin AI. This could save you money in other ways, which could make you feel better about the amount of risk you’re taking right now. Some reasons why you might want to do this:
- Your account management fees are higher
You can’t change how the market works, but that doesn’t mean you have to pay more. If you switch to an institution with lower fees, like Tenjin AI, your long-term returns might not be hurt as much.
- Your portfolio allocation is wrong
You should take less risk with your money if you need it soon. Not sure how much risk you should take? When you set a financial goal with Tenjin AI, we’ll suggest a risk level based on how long you have until you want to reach your goal and how much you want to earn.
- You own mutual funds that give you money from your capital gains.
When the manager of a mutual fund sells the investments that make up the fund, they may make a profit (called “capital gains”). This profit is then given to shareholders like you. These payments are subject to taxes. Even worse, mutual funds can pay out capital gain distributions even if the fund’s overall performance has been down for a year. So, if the market is unstable, your portfolio could lose value and you might still have to pay taxes on the fund’s gains. Most exchange traded funds (ETFs), on the other hand, pay less tax.
STICK TO YOUR PLAN.
When you know your team has your back, it’s easier to keep going. Our automatic features make the ride a bit smoother:
Rebalancing your portfolio means that we keep your account at the mix of stocks and bonds that you want.
We help you get the most out of risk management by making sure that your losses are balanced out by your financial goals. .
