How to Stay Sane in a Volatile Market

CATEGORIES: Education Center

Volatile stock marketAsset markets can be unsettling. The stock market feels volatile, directionless and buffeted by multiple variables.

Even the most seasoned veterans can feel anxious about market cycles. These three suggestions can help you to keep your head when everyone around you is losing theirs.

#1: Turn off the News

Many “financial news” networks are more concerned with providing entertainment than giving thoughtful investment advice.

One of the most awful phrases in the English language is: “The market closed up (or down) today because of X.” X is home prices or unemployment numbers or the IPO of XYZ Company.

This news is always accompanied by the stock photos of homes with foreclosure signs, long queues outside the unemployment benefits office, or XYZ Company employees popping Champagne corks.

In reality there is no X. There are billions of X factors that shape what the market does. More than 99% of the time there is no correlation between any single event and the movement of the stock market.

The larger point to make here is that the short-term is unknowable. Financial news shows like to focus on the short term because it offers more drama. It’s entertaining, but it may not help you make better long-term investment decisions.

#2: Measure Risk

Risk and return are two sides of the same coin. We sometimes forget that to properly measure the performance of our assets, we have to consider how much risk we assumed in getting that return.

Risk matters for two big reasons. First, it relates to your capacity to assume large short-term losses. This capability will relate to your financial means, time horizon and so forth. An asset that produces an expected 25% annual return over 5 years may not be a great investment if its average annual volatility is also 25% and you will be needing the money two years from now to pay for your kid’s college education.

Second, risk relates to your propensity to endure the stomach-churning volatility you see in those short-term daily price moves. Propensity has more to do with emotion than with financial means. Some people are better at keeping their emotions in check than others and can resist succumbing to the fear and greed that lead to bad investment decisions.

#3: Diversify

The Golden Rule of Investing: your chances for long-term success are much higher when your portfolio is properly diversified.

To be diversified means to have a combination of assets that behave in different ways. Start with broad investment categories: stocks, bonds and alternative assets (things like commodities, real estate, currencies and hedge strategies).

Within a single investment category (such as equities), hold different asset classes, such as domestic stocks, foreign stocks, value, growth, large cap, small cap, etc. Within each asset class, hold different industry sectors.

Diversification may seem suboptimal in the short run. If the stock market goes on a bull tear then a portfolio containing bonds and other things probably will not do as well as one hardwired to an equities index. But over the long run the economy will probably go through periods of inflation, deflation, growth, recession, euphoria and manic depression. Diversified portfolios will survive these twists and turns better than those that are more vulnerable to the threats each different market cycle brings.

No one single strategy is guaranteed to be a surefire success. However, following these three principles should help you weather the storm.

Learn more about how to diversify your portfolio at Jemstep.com

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About the Author

Katrina Lamb is a CFA for Jemstep. She has over 25 years experience in economics, finance, international development and management strategy, with a strong focus on global markets. She provides a voice of clarity, logic, and reason in an environment characterized by high uncertainty.

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