5 Timeless Tips on Managing Market Ups and Downs

Market volatility can be unsettling, for even the savviest of investors. In this article we provide you with some tips on how to manage – and potentially benefit from – market volatility.

The notion of investing in the stock market without volatility is as illusory as a car without an engine. Like it or not, the two concepts invariably go hand-in-hand. But does that mean you should avoid volatility – and investing – altogether? Market uncertainty can naturally cause panic and lead to poor investment decisions yet by recognizing short-term market uncertainty for what it is, you can help ensure that it doesn’t derail your long-term goals. Here are five tried and tested principles that can help you gain needed perspective.

"Investing is most intelligent when it is most businesslike "

- Benjamin Graham

Investors generally feel a financial loss about two and a half times more than a gain of the same magnitude. Understandably, many of us experience a roller coaster of emotions when investing (as the diagram below illustrates), which can translate into poor buy and sell decisions. Being aware of these emotions during periods of increased volatility can help you avoid reaching for the antacids and keep you on the straight and narrow to reaching your goals.

Source:  Darst, David M. (Morgan Stanley and Companies, Inc.). The Art of Asset Allocation, 2003.

Why shouldn’t you automatically sell your investments when market uncertainty sets in? Because trying to time the ups and downs of the market is a bit like rolling the dice.

As the illustration below demonstrates, over a 10-year period if you’re out of the market for even a small number of days when the market is outperforming, you can substantially reduce your return potential. Staying invested – while not always easy – can potentially translate into a better outcome.

time not timing graph

Risk can be a loaded term when it comes to investing and is often misunderstood. Often seen as synonymous with risk, volatility simply measures how much the return of an investment or the broader market fluctuates, both up and down. While some may fixate on these fluctuations, the permanent loss of capital should be of greater concern. Reducing exposure to securities that are perceived as 'risky’ will certainly lower market risk, but by doing so, long-term investors can be unduly exposed to inflation and longevity risk (the risk that you’ll outlive your savings).

Whether we like it or not, investing in the stock market and risk are a package deal. The key to long-term success is to manage your exposure to risk by using time and diversification to your advantage.

Diversification’s impact on three-year returns
While the performance of any portfolio can swing significantly each year, a balanced portfolio has historically resulted in fewer negative returns when compared to an all stock portfolio over the long term.

Equity and Banlanced portfolio Graphs

Often equated to not putting all your eggs in one basket, diversification is a tried and tested technique that mixes different types of investments in a portfolio to lower risk.

By including investments that are less correlated to one another – or react differently to economic and market events – gains in some can help offset losses in others. As the chart below illustrates, a diversified portfolio of different asset classes provides the opportunity to participate in potential gains of each year’s top winner while aiming to lessen the negative impact of those at the bottom.

Calendar year returns
asset class and index information for above chart
source image

Dollar-cost averaging is an investment method used to help reduce the risk of timing a lump-sum investment. By investing a fixed dollar amount on a regular basis, the “dollar-cost averaging” process helps control the effect of market volatility by smoothing out the average cost per unit of mutual funds purchased. Over time, and in certain market conditions, it could result in a lower average cost and a higher return. The accompanying chart simulates a dollar cost averaging strategy with a lump sum purchase from September of 2007 to September of 2009, a period punctuated by extreme market volatility and a significant correction.

While it’s important to note that dollar-cost averaging doesn’t always produce a better result than a lump sum purchase, its systematic approach makes investing easy and takes the guesswork out of deciding when to invest.

Dollar cost averaging Graph

Source: 1832 Asset Management LP and Morningstar Direct. Illustration is based on a hypothetical investment in the S&P/TSX Composite Total Return Index. It is not possible to invest directly in an index. 1 Dollar-Cost Averaging illustration assumes 25 contributions of $400/month made between September 2007 to September 2009, totaling $10,000 in contributions. 2 Lump Sum illustration assumes a one-time $10,000 contribution was made in September 2007.

Short-term market ups and downs can cause even the most experienced of investors to lose sight of the big picture. An advisor can help you develop a financial plan, recommend suitable investment and navigate rough waters. In fact, research on the value of advice has shown that investors find they have better savings and investment habits and almost four times the wealth of those who don’t have an advisor.

With the help of your Scotiabank advisor, understanding your initial reactions to market ups and downs can help you make better investment choices and view your portfolio more objectively.

value of advice image

Staying invested during market ups and downs is simple – but not always easy.  
Contact your Scotiabank advisor today to develop a plan that makes sense for you.