In September, the U.S. stock market fell when investors worried that a divided Congress would not resolve the federal budget and debt ceiling issues. But as a settlement took shape, the Dow began to rise again and today it’s greed rather than fear that’s the dominant emotion on Wall Street — at least for a few months.
With their dramatic ups and downs, stocks are one of the most volatile asset classes. As I noted in a May column, investors tend to respond emotionally to these short-term changes, especially the downturns and many times make damaging investment decisions.
Since the financial markets are affected by global events, such as political turmoil, economic downturns and environmental problems, it’s clear that volatility will continue to be an important consideration for investors.
But rather than be afraid of volatility, you may want to look at ways to take advantage of it. For example, you might want to use a technique called dollar-cost averaging to purchase assets on a monthly or quarterly basis, regardless of market values.
Let’s say you decide to invest $1,000 a month and your initial purchase is a stock priced at $10 a share, giving you 100 shares. The next month you invest another $1,000, but the stock price has fallen to $8, so you can buy 125 shares. The third month, the price has climbed to $12 and you buy 83 shares.
After three months, you will own 308 shares — a better outcome than the 300 shares you would have if the price stayed at $10 the whole time. Of course dollar cost averaging doesn’t guarantee a profit or protect against loss in a declining market, but it can be a solid strategy when adding funds to a volatile stock market.
Another strategy is to look for assets that have fallen in value during a downturn and increase those holdings at a time when others are selling. It’s like finding a bargain when you shop at your favorite department store. After all, the classic way to make money in stocks, or other types of investments, is to buy low and sell high.
In any case, it’s important to review your portfolio on a regular basis and “rebalance” your assets if necessary. Let’s say the U.S. stock market has been on an extended upward run and equities now make up more than 50 percent of your portfolio’s total value. If your financial game plan calls for 30 percent U.S. equities, it may be prudent for you to sell some of those stocks and invest those gains elsewhere. For example, many investors today don’t like European stocks, which have underperformed for the past few years, but have the potential to appreciate in the future.
Even though U.S. stocks may be generating great returns at the moment, it’s dangerous to get greedy and expect those returns to continue indefinitely. That approach would put you at greater risk when the U.S. stock market changes direction and starts going down again.
Remember that volatility is here to stay. Don’t be ruled by your emotions, and stay focused on your long-term investment goals.
Andrew Menachem, CIMA, is a Wealth Advisor at the Menachem Wealth Management Group at Morgan Stanley in Aventura and teaches at the University of Miami. Views expressed are those of the author, not necessarily Morgan Stanley, and are not a solicitation to buy or sell any security. The strategies and/or investments referenced may not be suitable for all investors.