Don’t panic: Selloffs and volatility call for discipline, not impulsiveness.
Experts have studied volatility triggers for decades. Some believe political uncertainty and economic instability are the main drivers. Volatility can also result from an imbalance between the volume of buy and sell orders, unexpected earnings results, drops in investor confidence, and an oversupply of initial public offers.1
Newer contributors also thought to cause market fluctuations include intraday trading, short sellers, global economic instability, instant news reporting, algorithmic trading, dark pools, and institutional investors trading in large stock blocks.2
Dollar Cost Averaging
One technique many active investors use during volatile markets is dollar cost averaging (DCA). This means gradually building up an investment position over a period of time using equal contributions of cash you have on hand.
The opposite of DCA is lump sum investing, meaning investing all of your money into an investment in one big shot. While some studies have found lump sum investing to have 66 percent greater returns than dollar cost averaging, DCA may help minimize risk in the event that prices continue to descend.3
Look To The Horizon
When the stock market is plunging it can be challenging not to panic. However, rash trading decisions based on emotions can hurt your performance, especially in accounts with long-term focuses, like IRAs and 401(k)s.
Try to avoid overreacting to short-term fluctuations by refocusing on your long-term goals. If you need reassuring, do your homework to find out how markets have reacted in the past. While past performance is no guarantee of future results, if you pull up a historical performance chart of the Standard & Poor’s 500, you can see how the market has reacted to downturns.4
Pay Closer Attention To Beta
Beta measures how closely an investment’s movement follows that of the broader market, typically expressed as a comparison to market benchmarks like the Standard & Poor’s 500.
Stocks with a beta of 1 move in line with the market. Beta less than 1 indicates a stock is less volatile than the market and vice versa for beta values over 1.
Sectors that historically have lower beta include utilities (0.48), consumer staples (0.58), and health care (0.7).5
Investing in stocks with low beta can be attractive to investors during periods of high market fluctuations.
This Has Happened Before and Can Happen Again
Remember that this isn’t the first time the market has experienced volatility. It’s just a part of investing.
Use times of duress to reassess your financial goals, analyze your existing holdings, rebalance where needed, and deploy capital. Practicing investing discipline in a volatile market can help you weather the ups and downs.
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1 Martin, Frederick, Benjamin Graham and the Power of Growth Stocks, McGraw-Hill, 2013.
2 Grayson, Lee, “What Causes Swings In The Stock Market,” Zacks.com, accessed August 20, 2015.
3 Kiersz, Andy, “How to Invest in Stocks if You’re Convinced the Market Will Keep Crashing,” Business Insider, August 24, 2015.
4 Russell, Rob, “ABCs of Investing: Alpha, Beta and Correlation,” Forbes, July 15, 2015.
5 Investopedia, “Beta,” Investopedia.com, 2015.