Risk is an inevitable component of investing, and market volatility is one of the factors that create investment risk. A large part of dealing with risk is working with an advisor who can help you manage your expectations and guide you through the ups and downs of a turbulent market. There is no single, universally correct strategy for risk. Every strategy is subject to your individual financial life needs. Consultation with an advisor can help you understand what approach works best for your situation.
Beyond setting realistic expectations, here are eight potential strategies – four long-term and four short-term – for managing volatility within your investment portfolio.
- Wait it out.
If you have consulted with your investment advisor and set a reasonable investment plan to meet your long-term financial goals, the best strategy may be to endure any short-term fluctuations. Let your long-term plan do its job. Although past performance does not guarantee future results, the stock market’s value has historically trended up over the long term, in spite of volatility.
- Create a mix of asset classes with low correlation.
Build a portfolio with investments that have historically moved out of sync. For example, when equities as a group have fallen in the past, bonds have tended to rise. There is no guarantee this will happen in all cases, but it may help mitigate some kinds of risk.
- Diversify your equity portfolio.
In addition to mixing it up among asset classes, consider mixing different types of stocks that are less likely to rise and fall together (i.e., have low correlation). You might diversify among domestic and international equities; small-cap, mid-cap, and large-cap stocks; or stocks in different sectors, such as technology, energy, transportation, etc.
- Consider dividend-paying stocks.
Dividends may provide you with a relatively steady return, regardless of the volatility in stock prices. It doesn’t reflect well on a company that ends dividend payments, especially if they are long-established. Doing so can influence shareholder confidence and stock prices. Therefore, companies tend not to offer dividends unless they are well established, cash-rich and secure in their ability to ride out some volatility.
- Make tactical shifts among asset classes.
Although sticking strictly to your long-term plan may be best, watching a portfolio drop in value can create anxiety. If you are concerned that a downturn in the stock market may continue for months or years, one relatively simple short-term strategy is to increase the percentage of your portfolio in cash temporarily. Of course, this reduces your opportunity for gains as well as your potential for losses, so consider such a move carefully. Moving back and forth from stocks to cash does involve predicting market behavior, and the results will depend on the accuracy of your predictions.
- Trade smaller positions.
When you have long-term financial goals, most of your assets should remain in long-term positions. If you want to make short-term trades to fund short-term goals or for other reasons, consider putting aside no more than 10%-20% of your portfolio value for this purpose. And when you are making short-term moves in a volatile market, consider making your moves smaller. Reducing the size of your trades can help contain your losses, although it will also limit your potential gains. And if stocks continue to drop, short-term moves won’t always be able to fund short-term goals.
- Take some profits off the table.
This is akin to making a tactical shift among asset classes. If you’ve made gains through short-term trading, you can lock them in by turning at least some of them into cash. While this can reduce future gains, it may also prevent loss of the gains you’ve already made if the stock dips back down.
- Take advantage of market hedging and limiting strategies.
There are a number of strategies that short-term traders use to limit risk, including limit and stop orders, options and puts, alternative investments, etc. All of these strategies have distinct pros and cons. If you are considering them, consult with your financial advisor first and make sure you understand their overall potential impact on your portfolio value.
Investing experts used to advise removing all emotion from investment decisions. However, as humans, that simply isn’t possible. “Behavioral finance” is a discipline that studies how human beings actually respond to things like risk, volatility, and loss. For example, our grief over a loss is likely to be twice as strong as our elation over a gain. Understanding how we are wired as humans, along with our individual personalities, helps us choose risk strategies that support our lifestyle and peace of mind. No strategy comes without risk. It’s a good idea to discuss your attitudes toward risk with a United Capital financial advisor who understands how important they are. Your advisor can help you manage investment expectations and risks in the ways that suit you best