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Why Understanding Market Volatility is Important for Investors

Stock market volatility is a measure of how much the stock market’s total value fluctuates up and down. Stock market volatility can increase when external factors such as inflation and the COVID-19 pandemic create uncertainty for the economy. This volatility contributes to investment portfolio gains and losses. Understanding market volatility should help you gain more often than you lose.

Volatility and Risk

Volatility and risk, although intertwined, are not the same thing. Volatility as a measurement can only be positive but can be viewed by investors as negative as it is often associated with the riskiness of an investment. Whereas risk is necessary and is positively correlated with return, the greater the risk the higher the potential return.

Short-term market volatility is not much more than noise and can be ignored by long-term investors as they hold their investments through many market cycles. Volatility can be more important to those who need to liquidate their investments in the short-term, such as recent retirees.

Risk is more of a factor when investing in individual stocks, where higher returns are expected in return for a greater uncertainty around their value.

Volatility and Your Returns

Volatility in the stock market is inevitable. Typically, sudden deep bear market declines are followed by prolonged bull market recoveries.

There is no perfect analysis to foresee market changes, predict how long they will last, or predetermine the movement in the market. The only certainty is that rising (bull) markets will eventually decline and declining (bear) markets will rise again.

A comprehensive long-term investment plan specific to your personal financial situation should position your investments with respect to the typical volatility of normal market cycles.  

Dealing With Market Volatility

When you understand that market volatility is inevitable and is a component of making profits from the stock market, you are in a good position to protect your investments. But, what can you do to further lessen potential losses or make gains from volatility?

Maintain Your Long-Term Focus

Adhere to your long-term investment-plan. Especially, ignore short-term volatility (noise) and avoid reactionary and impulsive portfolio buying and selling. Do not attempt to time volatility shifts. Remember, time in the market is better than timing the market.

Lessen Volatility Effect by Making Regular Investments

Emotionally, it is very tempting to buy into a market downturn. However, it is always better to employ an investment strategy that works in the long-term and removes guesswork and market timing decisions.

Using dollar-cost averaging can diminish the impact of volatile markets. By investing a set amount regularly, such as monthly, you can average out your investment costs. You can also avoid the risk of making lump-sum investments in the market at a time that may turn out to be a market peak.

Remember to Rebalance

Market volatility can wreak havoc with your relative stock and asset class weightings. During periods of volatility, you should ensure that your portfolio allocations still align with your risk tolerance and investment time horizon. This usually involves selling stocks that have increased in value and adding to stocks that have lost value to get your portfolio back to your target stock weightings.

Maintain Communication with Your Investment Manager

The financial professional(s) that helped you establish your long-term investment plan can provide you assurance through periods of market volatility. They will advise you on portfolio adjustments to keep you on target to meet your investment goals.

In Conclusion

Understanding market volatility can help you decrease losses and add to gains when constructing your long-term investment plan. Working with a qualified financial professional will provide you the expertise to invest effectively through volatile markets.

This content is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this content should consult with his or her financial partner or advisor.

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