How Market Fluctuations Can Benefit Investors
Sir Isaac Newton’s famous observance, “What goes up must come down,” rings especially true during periods of market volatility. In the past few months, it seems that as soon as investors’ portfolios begin to rebound from the last market drop, the market drops again. While these constant ups and downs can be disconcerting, there are several upsides to market volatility.
Market volatility creates opportunity.
While it’s very difficult to time the market, periods of volatility provide an opportunity to purchase shares of equities at lower-than-normal prices. For example, if you’re bullish on the stock market overall, making additional investments when the market drops may allow you to purchase a stock that traded at $50 a short time ago for $25. This lowers your cost per share and can help improve your portfolio’s overall return when the market rebounds again.
One great way to take advantage of lower prices is through dollar cost averaging. This is the process of investing an equal amount at regular intervals. By continuing to invest regardless of an asset’s current share price, you’re able to purchase more shares when prices decrease and fewer shares when prices are high.
Market volatility forces businesses to innovate.
If “a rising tide lifts all boats,” a falling tide sinks boats that are unwilling to innovate. In other words, when the stock market steadily rises, most corporations experience growth. However, when the tide goes out and market prices drop, it becomes apparent who the innovators are. Market volatility can force companies to trim excess spending, focus on their best ideas and come up with new and innovative ways to distinguish themselves from their competitors.
Market volatility makes investors pay attention.
Sustained periods of stable, predictable returns often lull investors into a false sense of security. This may prompt investors to take on too much risk in hopes of achieving even greater returns. A steep, unexpected market drop can serve as a wake-up call to those who had drifted away from their target risk tolerance. Market volatility is a great reminder of the importance of developing a long-term investment strategy that takes into consideration your risk tolerance, time horizon, goals for the future and current financial situation.
Market volatility drives improvement in investment strategies.
When the market continually ticks upward, it’s easy for investment managers to attract clients and grow their assets under management. However, periods of volatility can highlight areas of weakness in their investment strategies. A quality investment manager will use market volatility as a stress test and respond by coming up with new ideas that improve upon the previous strategy.
For example, during the market crash of 2008-09, many investment managers realized their strategies were more closely correlated to the markets than they had realized. As a result, some of these managers began researching ways to diversify beyond stocks and bonds into various types of alternative investments. This resulted in the emergence of a whole new asset class for individual investors. Previously alternative strategies had only been available to institutions and the very wealthy, but market volatility prompted the development of alternative investment strategies with the necessary liquidity and transparency to be appropriate for individual investors.
You may be wondering, “What’s the best way to invest during periods of market volatility?” As with so many financial planning issues, the answer is, “It depends on your particular situation.” For example, an investor who plans to retire in five years will take a different approach than a 25-year-old just beginning to invest. The best strategy is to work with a qualified wealth manager to develop an overall portfolio allocation that’s in line with your financial goals, current situation, risk tolerance, time horizon, retirement income needs, estate planning goals, etc.
At Creative Planning, our experienced teams start by helping each client develop a custom financial plan specifically designed to achieve his or her goals. We then use this plan as a blueprint to guide all portfolio decisions. The result is a custom portfolio built around your needs that is designed to weather market volatility.
If you’d like help developing your investment strategy, or with any other financial matter, schedule a call with a member of our team.