What You Can Learn from Volatility in the Markets

May 13, 2016

Learn From Volatility

If you’ve watched business news or read any financial publications lately, you’ve probably heard a lot about market volatility. Defined simply as the day-to-day stock market swings, the topic is almost single-handedly responsible for most of the panic-inducing financial headlines produced by the media.

Many investors feel anxiety at the mere mention of the word volatility because it has the potential to threaten something that they value most: their money. But even as unsettling as a steep decline in the stock market can be, there are several key takeaways that could positively affect your long-term financial health.

Here are a few lessons that you can learn from volatility in the markets.

Volatility Is Normal

As much as the media tries to make it appear that market volatility is currently at it’s worst and climbing.. it’s not!

In fact, it’s widely understood that one of the most difficult aspects of investing in the stock market is the risk/reward trade-off that is required to realize higher returns. And although high volatility can cause concern for investors because of the inherent risk involved, it is the nature of markets to have both gains and losses in the short term.

Consider the uncertainty that was present in the market at the beginning of 2016. This is just one example of the many emotional ups and downs that the stock market takes us on from time to time.

While volatility is inevitable and there’s little that can be done to prevent it, it’s important to understand the cycle and learn to react rationally in order to meet your long-term financial goals.

Recognize Your Blind Spots

Making important financial decisions can be overwhelming, and in some cases, downright terrifying. For some, it’s conscious avoidance. In others, unintentional self-sabotage.

But no matter the underlying reason, avoiding certain aspects of your finances altogether can halt your efforts to make progress with your money.

This is why it is important to recognize your financial blind spots. To risk stating the very obvious, blind spots by nature they are difficult to observe. But don’t worry, this is nothing that a little introspective reflection can’t help.

The key to success in this assessment is to be objective and search out the aspects of your financial life that you may have neglected. And although it’s easier said than done, pinpointing your blind spots is the only way you will be able to effectively move past them.

In many cases, the expert opinion of a trusted financial planner can help identify any major areas of weakness and assist in designing a strategy to fill in the gaps.

The Importance of Perseverance

Staying the course doesn’t have quite same sizzle as actively moving in and out of the market, but it is likely the best thing to do in a volatile environment. In fact, market volatility is the primary reason that many investors engage in bad financial behaviors — specifically buying high and selling low.

Keep in mind that volatility and market fluctuations are much different than a realized loss. A temporary drop in value doesn’t present a huge problem if the investor is able to persevere.

For this reason, investors with a long-term perspective rarely show concern over volatility. They understand that a permanent loss does not occur unless they cave to the emotional pressure and sell during a downturn. Simply put, don’t allow market movement to deter you from remaining steadfast in the application of your financial strategy.

Diversification Is Key

Diversifying your investment portfolio is one of the best strategies to reduce the impact of market volatility. Although diversification does not eliminate the possibility of losses in the market, it has the potential to manage your overall risk.

Because asset classes vary in performance depending on market conditions, a decline in one type of asset is typically offset by a gain in another.

Think about the most recent financial crisis of 2008. Between the early part of the downturn in 2007 through 2009, the S&P 500 lost upwards of 55%. As you can imagine, more aggressive portfolios lost far more than that while properly diversified portfolios, overall, fared slightly better.

Now this isn’t to say that investors should completely ignore all financial news in favor of a set-it-and-forget-it diversification approach. That is a far too simplistic of a route to take. Although a significant amount of the doom and gloom rhetoric from the financial media is ratings driven, turbulence in the markets should serve as a reminder to periodically review your long-term plans and make sure that they are still on track.

Remember: the only time to adjust your portfolio is when your financial goals change, not the headlines.

In the end, the market can be a harsh teacher if we overreact to every fluctuation. But if we really pay attention and stick to our strategy, there are some valuable lessons to learn.

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