In investing, volatility is a measure of the size and frequency of price fluctuations. A highly volatile asset is one whose price could often either rise high above its average or, alternatively, fall well below it. The greater the number of potential outcomes, the higher the volatility.
Sometimes, entire markets can become volatile. In late October, the Chicago Board Options Exchange’s Volatility Index (also referred to as the ‘fear gauge’) reached its highest level in more than six months. However, the Volatility Index, which measures the extent prices are expected to rise or fall over 30 days, remains below its 2022 average.
Increased volatility can sometimes be indicative of broader, underlying concerns with an asset or market, although that’s not always the case. Ultimately, volatility is an inevitable part of the investing experience, with year-on-year returns varying by as much as 15 per cent annually, and up to 30 (or more) per cent in periods of peak volatility, typically once or twice a decade.
While volatility may be stressful, it can also create opportunities for investment growth and success. If you’re looking for ways to manage and navigate a volatile market, here’s what you need to know.
Stay calm and stick to your plan
Smart investors work to a plan, often created in partnership with a financial advisor. Rather than reacting rashly when prices plummet (and sometimes even when they rise), smart investors know the best course is to stay focused on their long-term goals. Fear and greed are both powerful emotions, perhaps never more so than when money is involved. However, panicked decisions are seldom smart, and tend to either lock in losses or limit gains.
For some investors, of course, the long term isn’t quite as long as it used to be, which affects decisions on how to invest and can increase the impact of exposure to volatility and downturns. That’s why all investment plans need periodic updates to reflect life changes and developments, and reduce the risk of volatility as retirement draws near.
If you don’t have an investment plan, now’s the time to get one. If you already have one, make sure it’s up to date and determine whether recent market volatility requires you to make any adjustments.
Maintain balance in your portfolio
A strong portfolio is a balanced portfolio. Concentrate your holdings too tightly in any one area of the market and you increase your risk of exposure to volatility if that whole sector takes a serious hit.
If market volatility is impacting your asset allocation mix, don’t be afraid to take some profit from one area of your portfolio, then use the earnings to buy elsewhere and restore the balance you’re looking for.
Consider increasing your investment holdings
While it can be hard to watch as prices swing wildly, don’t let volatility stop you from investing. If it helps, take the optimistic way of approaching investing in volatile times: downturns are simply an opportunity to invest at a discount. This thinking applies to purchases you would have made anyway and is known as dollar-cost averaging, where you spread out investment purchases over regular intervals.
Of course, if volatility drags the broader market down, there will likely be opportunities to buy desirable assets at bargain prices, sometimes saving one third (or more) to acquire investments with strong track records of performance.
Make sure you have an emergency fund that meets your needs
To avoid any negative consequences associated with extreme market volatility, it’s wise to have a healthy emergency fund stashed away as cash somewhere, preferably a high-interest savings account that lets you access as much of your money as you need at any time without penalty.
Generally, financial experts recommend maintaining an emergency fund big enough to cover between three to six months of living expenses, but it’s wise to increase this amount as you grow older, with the goal of eventually being able to cover 12 to 24 months. At this advanced stage, you can spread the money between cash, bonds, life insurance, a home equity line of credit, and other assets that aren’t linked to market performance.