By Karen Codman, Business Planner
We’ve seen a lot of wild swings in the market lately. In one week, the broad market lost nearly 5 percent of its value after a long period of steady gains. Since then, the market has been up one day and down the next.
In some cases, it swings from being up a hundred points to being down even more, all in a few hours. Investors had finally gotten used to a more sedate market environment and now suddenly people are faced with the return of the dreaded “V-word” … volatility.
Volatility, a measurement of how much fluctuation there is in equity prices, is not quite the same thing as risk, but for most people there is not much of a difference, especially since high volatility is associated with periods of low or negative stock market return.
A volatile market environment is more challenging for investors. Individual investors tend to get whipsawed by the emotional aspect of investing.
When the market declines sharply, they often cash out to spare themselves further pain, only to watch the market rebound without them. And while buy-and-hold investors who wait out the market turbulence can avoid a lot of long-term damage, their short term performance will suffer along with that of the broad market.
In this environment, regular rebalancing can do a great deal to reduce the volatility of your own portfolio and could even generate better returns than the market if conditions are unstable enough. When you rebalance, you start by establishing a target allocation for your funds.
Over time, as different investments perform differently, your portfolio will diverge from your targets. So periodically, you reallocate your portfolio to bring it back in line with the plan.
What makes this work well in volatile markets is that you will tend to accumulate more assets when they are relatively cheap, while assets that have experienced a run-up will be partly sold off, locking in gains.
Rebalancing works best when your portfolio has several non-correlated assets. If all of your holdings move the same way, there’s not a lot to rebalance.
Additionally, unless your portfolio is in a 401K, IRA or other qualified plan, rebalancing may make your gains subject to taxes. And there are several different methods of rebalancing, each of which is best suited to a particular circumstance and investment style.
In volatile markets, the most important thing is to develop an investment plan and stick with it. If you have had trouble with emotional investment decisions in the past, you may want to consider working with a financial advisor. An advisor can help you rebalance your portfolio appropriately, keep to your investment targets and avoid costly mistakes like making emotional decisions.
When market gyrations give you a stomachache, remember that rocky market conditions are only temporary. And market volatility can also offer opportunities for the prudent investor.
Over the long run, if you decide on a solid investment program and stick to it, you will be well on the road towards establishing your financial future.
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Karen Codman is a financial advisor specializing in personal wealth management. She can be reached online at www.karencodman.com.
