Key takeaways
Market volatility can be caused by unexpected economic news, changes in Federal Reserve monetary policy and global events, among other factors.
Having a financial plan in place, re-examining your risk tolerance and maintaining an appropriately diversified portfolio can help you prepare for and better weather market volatility.
A financial professional can help you adjust your plan to protect your assets and capitalize on new opportunities.
Experienced equity and fixed income investors know that a diversified stock and bond portfolio is the key to wealth accumulation, but also realize that markets don’t move in a straight line. From time-to-time, markets experience increased volatility. In the stock market, this can occasionally lead to market corrections (a decline of 10% or more from peak value) or even bear markets (declines of 20% or more).
For example, between July 10 and October 17, 2024, the S&P 500 Index rose 3.7%. However, within that roughly three-month period, the index repeatedly moved up-and-down. While the temporary downturns may have concerned investors as they occurred, ultimately, by mid-October, the U.S. stock market reached new all-time highs. Investors need to be prepared for this type of short-term volatility.
“Episodes like this tell investors a lot about their tolerance for risk,” says Rob Haworth, senior investment strategy director with U.S. Bank Asset Management. “You need to be prepared for the market’s risks, particularly when it has reached all-time highs.”
Understanding what causes market volatility may help you better manage the emotions and behaviors that come with it. Let’s explore market volatility and what can help you ride the waves, such as a comprehensive financial plan.
Stock markets sometimes experience sharp and unpredictable price movements, either down or up. These movements are often referred to as a “volatile market” and can occur over a period of days, weeks or months.
While the term “volatility” applies to both up- and-down-market movements, investors tend to be more concerned about downside volatility.
It’s important to recognize that significant, short-term changes in the market tend to be temporary. It’s also notable that volatility isn’t necessarily all bad: When markets decline, opportunities may arise to find good value in specific investments that experience a short-term drop.
While market volatility can happen with little warning, it rarely occurs for no reason. For example, a series of events seemed to contribute to the 2022 bear market.
Other factors can cause market volatility, including:
You should expect volatility from time-to-time but remember that these tend to be temporary stages in the markets. In fact, a market decline can provide investors a good value in specific investments that experience a temporary drop.
Because market volatility is temporary, it’s important to remain calm if your portfolio is affected. But there are also steps you can take to help you` better prepare for market turbulence.
A financial plan is “the foundation of investing,” says Eric Freedman, chief investment officer for U.S. Bank Asset Management. He emphasizes that sticking with a plan helps you avoid the urge to move money in and out of the market in reaction to price changes.
“Investors often find that market timing doesn’t result in a favorable outcome,” Freedman says.
As you create or review your plan:
Your emergency cash savings serve as a financial cushion during difficult times or to help you meet unexpected expenses. The conventional wisdom is that you should have the equivalent of three to six months’ worth of income readily available.
If your income fluctuates in economically challenging periods or due to the nature of your work, consider bumping up your emergency fund to meet expenses for six to nine months or more . It will provide peace of mind that you can get through challenging periods.
Your risk tolerance is one of the pillars of your investment strategy. From time to time, reexamine your views on investment risk.
A diversified portfolio that better weathers market volatility begins with owning an appropriate mix of investments aligned with your risk tolerance level. The mix of assets you hold should represent three broad investment categories: stocks, bonds and cash.
“In the current environment, we recommend investors consider a neutral weighting in their asset allocation mix,” says Haworth. “To more fully diversify within equity holdings, increasing exposure to foreign stocks may be appropriate as they appear much cheaper, historically, than they’ve been.” Another underperforming category, compared to large-cap U.S. stocks, are small- and mid-cap stocks, according to Haworth. They offer an additional diversification opportunity.
For those who still have a sense of caution about the stock market, “a dollar-cost averaging strategy is an effective way to help mitigate the risk of short-term market volatility when you put money to work in assets that can fluctuate in value,” adds Haworth.
Reassess your portfolio at least annually. And as your portfolio rises or falls in value due to varied investment performance, you may want to rebalance it to make sure it’s still aligned with your primary objectives.
Investors should always be prepared for market volatility. An experienced financial professional can review your current plan or guide you through the process of developing a plan to help you feel confident that you’re on track to your financial goals.
Even if you’re currently comfortable with your plan and investment portfolio, the economic environment can change quickly. A financial professional can help assess your circumstances and calibrate your plan as necessary to either help protect your financial position or take advantage of new market opportunities.
Your financial goals are the foundation of your financial plan. Learn about our goals-focused approach to wealth planning.
Volatility essentially measures the degree to which the price of an investment changes. Generally speaking, bonds are considered less volatile than stocks, though bonds can also experience price volatility, as bond prices can rise or fall during periods of interest rate changes. Different types of stocks or stock asset classes can also demonstrate different levels of price volatility.
Stock markets tend to be subject to less price volatility when the underlying economy is fairly stable. That often occurs during times of steady economic growth and modest inflation. Stock prices are ultimately a measure of the strength of a company’s earnings (profits). If earnings are growing steadily due to a favorable economic environment, markets tend to encounter fewer periods of volatility. Markets are prone to increasing volatility if a more unpredictable economic environment occurs or unexpected events develop.
Your investment time horizon and emotional response to market volatility are key factors in helping you assess your risk tolerance.
Setting and working toward financial goals becomes easier when you reflect on your intentions.
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