We can’t predict the future, but one thing’s for certain: The world is constantly changing, and the stock market is too. Sometimes, those changes can be dramatic.
When it comes to investing, your first instincts can often steer you in the wrong direction—especially when your portfolio drops.
It’s important to understand that market volatility is part of any investment portfolio.
“You have to embrace the volatility in the market,” says Pushti Kaushal, Financial Advisor at Cambrian and Aviso Wealth. “Don’t panic and take your money out, or you lose any chance of it recovering. If you stay, there is still a chance your portfolio will recover.”
Let’s dive into what market volatility means and why investments fluctuate, with advice from Pushti Kaushal:
Market volatility measures price fluctuations in the stock market. Markets will always ebb and flow; volatility is normal and to be expected with any investment.
If you’re afraid of volatility, you might be tempted to choose very low-risk investments. But this comes with a cost of its own: With less risk, you’ll typically make smaller returns.
This is called the risk-return relationship. In general, it means that the more risk you take on, the greater potential reward you’ll see.
“If you increase risk, returns may increase. With an aggressive portfolio, there is more risk attached, but you might get better returns in the long run,” says Pushti.
Example:
You open an investment account to start saving for retirement. To meet your retirement goals, you need an average annual return of 6% over the next 30 years.
You have the option to choose a more conservative portfolio (low risk, but with lower returns) or a more aggressive one (high risk, but with greater potential returns).
If you choose a portfolio that’s more conservative, you may not lose money—but you also might not earn enough to meet your retirement goal.
With a more aggressive portfolio, you’re more likely to meet your goal as long as you have enough time in the market. As your planned retirement date draws closer, you can re-balance your portfolio to reduce your risk.
You may be wondering what causes the value of your investments to fluctuate.
“There are so many reasons for market volatility, including the Bank of Canada interest rates and wars in other countries,” says Pushti.
A few of the main factors include:
From pandemics to natural disasters, global events have a definitive effect on the market. You can trace stock market dips to major events of the past, like the housing crash in 2008 or the pandemic in 2020.
If you’re very risk-averse, you might be tempted to keep your savings in a typical savings account rather than investing at all.
But if you do so, you’ll lose money every year due to inflation. Investing is one way to shield your savings from inflation.
Putting all your eggs in one basket means if that basket breaks, so will all of your eggs. Diversification in investing helps you spread the risk, so you aren’t as vulnerable to one particular risk.
“When you invest in mutual funds through our partner NEI Investments, you’ll invest in a diverse array of funds,” says Pushti.
“By investing in so many different funds, there’s a very slim chance that all the companies will go down at once—and this lowers your risk.”
It’s one thing to know that markets rise and fall—but it’s another to see those losses in your accounts. What can you do to better tolerate market volatility?
As soon as you see negative returns, it can be tempting to pull out all your money and minimize your losses.
But if you do, you could miss out on the market rebound—and you won’t regain the capital you lost. Stay invested to ensure you don’t miss out on those gains.
“People panic and take out their money because they don’t want to lose more,” says Pushti. “But if you take it out now, there is no chance of recovering what you’ve lost.”
“If you stay in the market and give it time, the value may come back up. Historically, the market always recovers.”
One way to view stock market drops is that you can buy in at a discount. When the markets fall, consider whether you should keep contributing to your investment accounts (or even contribute more) instead of selling.
“When stock prices are low, that’s the best time to invest—because you know that eventually, they may go back up,” says Pushti.
What if you suddenly need a lump sum of money, but your investments have taken a dip? This scenario is one example of why it’s important to keep an emergency fund on hand.
Rather than investing all of your savings, keep some money in an easily accessible account for emergencies.
One way to reduce your risk during a market downturn is to diversify your portfolio.
If you have a portfolio with just one type of investment—for example, shares of a single company—the value is entirely dependent on just one company. If that company drops in value by 20%, so does your entire portfolio.
Diversification is about spreading out risk in your portfolio. It’s investing in a variety of assets (including stocks and bonds) to reduce risk without sacrificing potential returns. This way, you aren’t overly exposed to one particular risk.
Let’s say one of your investments performed poorly during a short term period. With a diverse portfolio, those losses can be balanced out by other investments in your portfolio that performed better during that period of time.
With a better understanding of how market volatility works, you won’t be tempted to sell off your investments the moment markets change. And that means you can see greater potential gains once the market rebounds.
We can set you up with a portfolio that’s tailored to your risk tolerance, time horizon, and financial goals.
Before you make a rash decision, seek a second opinion by meeting with one of our advisors. Contact us today!
Disclaimer
Mutual funds and other securities are offered through Aviso Wealth, a division of Aviso Financial Inc.
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