Important legal information about the e-mail you will be sending. By using this service, you agree to input your real e-mail address and only send it to people you know. It is a violation of law in some jurisdictions to falsely identify yourself in an e-mail. All information you provide will be used by Fidelity solely for the purpose of sending the e-mail on your behalf. The subject line of the e-mail you send will be "Fidelity.com: "
Six strategies for volatile markets
A key to weathering market volatility is to be prepared. Here’s how.
Market volatility can happen at any time. Most recently, it has been triggered by a looming debt crisis in Europe and the U.S. Earlier this year, it was the Japanese tsunami and nuclear crisis, a spike in oil prices, and unrest in the Middle East and North Africa. Two years ago, it was the U.S. subprime credit crisis. Eight years ago, it was the Iraq war. The point: It happens often (as the chart below shows), and when it does, it can be unsettling for many investors.
“Nothing ignites the fear of losing one’s hard-earned money like a short-term market correction,” says Chris McDermott, senior vice president, investor education, retirement, and financial planning at Fidelity. “A natural reaction to that fear might be to reduce or eliminate any exposure to the stocks, thinking it will stem further losses and calm your fears.”
What seemed like some of the worst times to get into the market turned out to be the best times. The best five-year return in the U.S. stock market began in May 1932—in the midst of the Great Depression. The next best five-year period began in July 1982 amid an economy in the midst of one of the worst recessions in the post-war period, featuring double-digit levels of unemployment and interest rates.
What does this mean? It may not be prudent to bail out of the market when it is volatile. What is appropriate: Be prepared.
“Market volatility should be a reminder for you to review your investments regularly and make sure you have an investment strategy with exposure to different areas of the markets—U.S. small and large caps, international stocks, investment grade bonds—to help reduce the overall risk in your portfolio,” says McDermott. “We have found that those with formal investment strategies have an easier time riding out day-to-day market fluctuations.”
1. Have a strategy
Your time horizon, goals, and tolerance for risk, are key factors in helping to ensure you have an investment strategy that works for you. Your time horizon is the number of years until you will begin to use what you’ve invested. Your tolerance for risk should take into account your broader financial situation such as your savings, income, and debt—and how you feel about it all. Looking at the whole picture can help you determine if your strategy should be aggressive, conservative, or somewhere in between.
2. Be comfortable with your investments
If you are nervous when the market goes down, you may not be in the right investments. Even if your time horizon is long enough to warrant an aggressive portfolio, you have to be comfortable with the short-term ups and downs you'll encounter. If watching your balances fluctuate is too nerve-racking for you, think about re-evaluating your investment mix to find one that feels right. But be wary of being too conservative especially if you have a long time horizon. Set realistic expectations, too. Particularly if you are in or nearing retirement, consider covering essential costs with a low-cost guaranteed1 income annuity, rather than letting stock market performance dictate your income. That way it may be easier to stick with your long-term investment strategy.
One of the most important things you can do to help protect your portfolio from volatility and down markets is to diversify. While it won't guarantee you won't have losses, it can help limit them. It was put to the test during the extreme market volatility in 2008.
Now look at the performance of three hypothetical portfolios: a diversified portfolio of 70% stocks, 25% bonds, and 5% short-term investments; a 100% stock portfolio; and an all-cash portfolio. See chart below.
By the end of February 2009, both the all-stock and diversified portfolios would have declined. But diversification would have helped reduce losses compared with the all-stock portfolio.
Now look at March and April 2009. Our hypothetical all-stock portfolio would have risen the most, followed by the diversified portfolio, and then all cash. This is a good example of how such portfolios can behave in rising markets. If the market continues its upward trend, the diversified portfolio might gain less than the all-stock portfolio but more than the all-cash portfolio. This is what diversification is about. It will not maximize gains in rising markets, but it can help limit losses when the market is turning down.
So how do you diversify? First, consider spreading your investments among at least the three core asset classes—stocks, bonds, and short-term investments. You may also want to include other assets like commodities, real estate, and currencies, which are not always closely correlated with the core asset classes. Then, to help offset risk even more, diversify the investments within each asset class.
4. Do not try to time the market
Attempting to move in and out of the market can be costly, particularly because a significant portion of the market’s gains over time have tended to come in concentrated periods. Many of the best periods to invest in stocks have been those environments that were among the most unnerving. Investors face long odds in trying to time the ups and downs of the market, and Fidelity data shows they tend to increase their allocations to stocks ahead of downturns and decrease their exposure just prior to market rallies.
5. Invest regularly no matter what
If you invest regularly over months, years, and decades, you can actually benefit from a volatile market. Through a time-proven investment technique called dollar cost averaging, you invest a set amount every week, month, or quarter, regardless of how the market's doing. Over the years, you’ll buy more shares of each investment option when prices are low, and fewer when prices are high. As a result, the average price per share of your investments may be lower than if you invested all your money at once. More importantly, you avoid the temptation of trying to time the market. (Periodic investment plans do not ensure a profit or protect against a loss in a declining market.)
6. Consider a hands-off approach
To help ease the pressure of managing investments in a volatile market, you may want to consider an all-in-one fund for your longer-term goals such as retirement. These funds provide diversification with exposure to various asset classes and investment styles in a single fund, with the added benefit of professional asset allocation.
“Rather than focusing on the turbulence and wondering if you need to do something, focus on developing and maintaining a sound investing plan,” says McDermott. “You owe it to yourself to have a plan and keep it on track, especially during the market’s peaks and valleys.”
Before investing in any mutual fund, please carefully consider the investment objectives, risks, charges, and expenses. For this and other information, call or write Fidelity for a free prospectus or, if available, a summary prospectus. Read it carefully before you invest.
Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.
Share your thoughts about Fidelity Viewpoints.