After an extraordinarily smooth ride in 2017, the stock market has shown signs of becoming more volatile in 2018. There's no telling how long it will continue, but some level of volatility is normal.
No market has ever ascended for months in a straight upward line. This is a reality that investors must accept. What concerns investors is the effect on net returns that sustained high volatility might have. Volatility itself doesn't necessarily mean loss of value, but in the event that it does, protection from volatility is afforded by maintaining a diversified portfolio of high-quality investments.
All too often, high volatility prompts investors to sell low. Then, attracted to the numbers posted by stocks that are doing well on volatility's upswing, they often buy high. Of course, this is the opposite of what you want to do. Here is some advice for how you should stay the course during times of volatility.
1. Maintain a long-term focus. Don't get emotional over volatility. Keep a firm hand on the wheel to steer your financial ship through the storm, knowing you constructed it to take the chop. Maintaining a long-term focus requires you to block out the noise of media reports and have the discipline not to check your accounts every day. It will only serve to bother you and make you less likely to stay the course and give your stocks time to rebound. Remember: Volatility goes two ways.
2. Stay diversified. Stay diversified by asset class to balance out ups and downs among different types of assets, with gains counterbalancing losses. The principle asset classes are stocks, bonds and cash (money market). There are numerous others including commodities, real estate and other so-called alternative assets to traditional assets (stocks and bonds).
The benefits of diversification tend to occur in long-term portfolios — in 10- to 15-year periods, according to author and academic Craig Israelsen. Some market periods have been cited as exceptions. But the argument can be made that some of these periods aren't actually that. For example, the period from 2000 to 2010 has acquired the notorious moniker of "the lost decade" but this characterization tends to reflect an over emphasis on U.S. large-cap equities.
From 2000 through 2009, the S&P 500 Index cumulatively dropped 9.1 percent and the Russell 1000 Growth Index declined 33.4 percent. However, Joni Clark, CFA, CFP, points out in an analysis published in Advisor Perspectives in 2010 that various other equity indexes performed quite well during the same period, posting significant cumulative gains. Among these were the Russell 1000 Value Index (up 27.6 percent), the Russell 2000 Index (up 41.2 percent), the Dow Jones U.S. Select REIT Index (up 175.6 percent) and the MSCI Emerging Markets Index (up 154.3 percent).
"Once you look beyond U.S. large-cap equities and the gloom and doom on Wall Street, conditions really weren't too bad for stock investing," Clark concluded in 2010. Investors with equity portfolios that had broad diversification, affording sufficient exposure to these and other indexes that performed well in that decade, would have been able to offset domestic large-cap losses and, depending on their weightings, derive good net returns.