Market volatility and swings in economic performance are normal. Since 1945, the S&P 500 has declined between 5 percent and 10 percent a total of 78 times. The average portfolio recovered in just a month. And historically speaking, a bigger market drop happens every five to 10 years. But there’s good news: There’s never been a dip from which the market hasn’t recovered.
Still, fears of a market on the brink are enough to ruin any investor’s sleep. Read on to learn about market volatility and how to protect yourself.
Why Market Volatility Happens
Worries about trade wars, political uncertainty and economic data can all kick-start a market drop. Sometimes the cause is an overvalued sector (such as tech stocks in 2000) or a crisis like the housing market meltdown of 2007. National emergencies including earthquakes, terrorism attacks and wars have all touched off plunges.
How to Prepare for Volatility
Diversification is key to facing a volatile market with confidence. In addition to U.S. stocks and bonds, you may want to diversify into international stocks, which often don’t follow the same trajectory as domestic stocks. Look at additional investments such as real estate, venture capital (which funds start-ups with long-term growth potential) and commodities like gold.
Have a Cash Reserve
In a bear market, when stock values drop by 20 percent or more, you want enough cash to cover major expenses for the next couple of years. Even if you’re earning a salary, your cash reserve should cover big-ticket items such as school tuition and major home improvements. High-interest savings accounts, certificates of deposit (CDs) and short-term bonds are all good places to stockpile cash so you don’t pull money out of your portfolio when prices are reduced.
Know When to Tweak
If the market starts to slide and you are overly invested in stocks (you have more money in them than you are willing to lose in the short-term), sell some and put the money in bonds, CDs or high-interest savings accounts. Avoid buying new stocks until the market settles down again. Even if you’re in your 40s and 50s, do not panic and sell at the bottom. You still have at least a decade until retirement — plenty of time to recover. Retired investors should pull living expenses from their bond portfolio, letting their stocks sit until the market stabilizes.
Ride It Out
Volatility generally passes within weeks or months. In a worst-case scenario, market volatility should pass in a couple of years. Even after the 2008 downturn when the S&P 500 plunged 56 percent, it took the market between one and three years to recover. There is light at the end of the tunnel.