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Dealing with Stock Market Volatility

In the last week, the following questions (and several similar ones) have showed up in my inbox:

“With the recent downturn, I’m considering move my 401k to bonds until the market volatility stops.”

“I have a little cash to invest, but in light of the recent volatility, I can’t figure out where to put it.”

“When the news says the market is going nuts, I go in and check my portfolio. Then when I see a large loss I will get nervous. How does one overcome this scenario?”

Because I keep getting these types of questions, I suspect many of you have similar concerns as well. What follows are my four tips for dealing with the recent volatility.

First, give up on the idea that the volatility will stop. The stock market is always a bumpy ride. Sure, some months/years/decades are less bumpy than others. But even at times when the market has been marching steadily upward, there’s no way to know that a dip, a series of bumps, or even a cliff isn’t just around the bend.

As such, you only want to put money in the stock market if you’re OK with the fact that its value will bounce all over the place from day to day and from year to year. In other words, when designing your portfolio, choose an asset allocation that you can be comfortable with even during the most volatile periods.

Second, remember that underneath all this unpredictable, bumpy, noisy, random volatility is something valuable (and, for what it’s worth, much more predictable): A world economy that manages to continue growing despite setback after setback. If you’re in a position to be able to accept the accompanying volatility/randomness, you can have a share of that growth.

Third, remember that it’s all one portfolio. That is, even if one holding is doing poorly, there’s no need to worry as long as the overall portfolio is doing OK.

Fourth, try to keep a long-term focus. The value of your portfolio tomorrow is only important to the extent that you’ll be selling your holdings tomorrow. In other words, if you’re in the accumulation stage, it’s entirely irrelevant.

And for those in retirement, you’re (ideally) only liquidating a very small portion of your portfolio every year. What matters is the average price you’re able to get for your holdings over the entire duration of your retirement–not the price on any one particular day.

Updated to add: Taylor Larimore, one of the authors of The Bogleheads’ Guide to Investing shared a recent Barron’s article pointing out that, while we’ve had a volatile year so far, it hasn’t yet approached 2008 or 2009 in that regard.

  • In 2008, there were 42 days in which the S&P 500 moved more than 3%.
  • In 2009, there were 23 such days.
  • So far in 2011, there have been only 7 such days.

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Comments

  1. Volatility can also be a good thing-
    It gives you opportunities to buy some assets at a lower price than if the prices only grew steadily. For example every stock purchase I made in 2009 was a bargain, especially Mar of 2009.
    Volatility also gives you opportunities to sell assets at relatively higher prices. For example anyone that rebalanced in 1999 would have sold inflated stocks to buy the relatively cheaper bonds.
    >in light of the recent volatility, I can’t figure out where to put it
    The power of asset allocation is that you decide on asset %es then you don’t have to guess were to invest. Prices will change, but not all the prices change evenly. If stocks go down bonds may go up, or at least drop by a smaller percentage. You then buy and sell assets to return to your asset allocation %es… The best part is that what and how much you buy and sell can be calculated so there is no guessing. I even wrote a small program to do that calculation for me.

    -Rick Francis

  2. I want a solution that does not require me to make investing a career or my main hobby.

  3. Rob,

    I think most people share that sentiment.

    If you haven’t before, you may want to consider a low-cost target retirement fund. They’re not entirely hands-off, because you still have to check in from time to time (once a year or so should be plenty) to make sure the fund manager hasn’t changed the plan in terms of what asset allocation the fund will use. But they remove the need to bother with rebalancing or anything like that.

    One caution: If you decide to go that route, ignore the dates in the funds’ names. Rather, look at the asset allocation of each fund, and choose the fund with the allocation that suits you best.

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