Stock market volatility can be an opportunity for investors. Here’s why
The U.S. stock market is falling, again.
On Monday, all three major U.S. indexes slid, led by travel stocks, on fears that a Covid-19 rebound would damage the economic recovery. The Dow fell more than 700 points, while the S&P 500 dropped 1.6% and the and tech-heavy Nasdaq slumped 1.1%.
The sharp downturn came after all three indexes snapped weeks-long winning streaks Friday as inflation fears ticked up. Just weeks earlier, stocks were at all-time highs.
While volatility can be troubling for investors, experts caution against any hasty selling when markets fall. In addition, slumping stock prices can be a prime buying opportunity that investors should take advantage of.
Volatility is common
First, accept market volatility — which is relatively common — as a normal part of the process of investing and the best way to outrun inflation, said certified financial planner Brad Lineberger, president of Carlsbad, California-based Seaside Wealth Management, which manages about $165 million in assets.
“Embrace the volatility, because it’s why investors are getting paid to own stocks,” he said.
This means investors should stay calm even through extreme movements. As stocks have gyrated in recent months, long-term market returns are still based on the same things: dividend yields, earnings growth and change in valuation, according to Zach Abrams, a CFP and manager of wealth management at Shaker Heights, Ohio-based Capital Advisors, which manages around $800 million in assets.
Movements up and down can also be a good time to review your asset allocation. If you’re worried about a big drop, you could rotate part of your portfolio into some less-risky stocks to protect from a potential market correction, which is a drop of more than 10%.
For example, now may be a good time to look at consumer staples, according to Morgan Stanley analysts.
Volatility can be your friend
In addition, sharp moves down can also be opportunities to buy more stocks and set yourself up for future gains, according to Abrams.
This is because when stocks fall from recent highs, they’re trading at a discount and will likely rebound at some point, which sets investors up for larger returns.
Continuing to put money in the market when it’s down as opposed to selling is a great way to make sure you don’t miss out on a rebound. Data shows that selling when the market goes down can take you out of the game for some of the strongest rebounds.
For example, if you missed the best 20 days in the S&P 500 over the last 20 years, your average annual return would shrink to 0.1% from the 6% you’d have earned if you’d stayed the course.
And, even with the market’s recent downturn, stocks have had a strong performance this year. Through Friday’s close, the S&P 500 is up over 15% year to date.
Have an emergency fund
Of course, even if you know that stock market volatility can benefit you in the long-run, financial advisors still recommend having a cash emergency fund on hand so that you can make it through a market meltdown without selling.
If the stock market falls, it’s better to spend the money in your emergency fund than sell assets at a loss that can’t be recouped, according to Tony Zabiegala, chief operations officer and senior wealth advisor at Strategic Wealth Partners, an Independence, Ohio-based firm with more than $500 million in assets under management.
This also keeps stock investments in the game for big rebounds, which generally come shortly after market corrections or even smaller dips.
For example, an investor would have only needed three months to six months of living expenses in an emergency fund to avoid taking losses during the March 2020 meltdown, said Lineberger at Seaside Wealth Management.
This approach would have also kept investments in the market for the record-breaking rally stocks enjoyed after the pandemic slump.
Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.
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