You can’t turn on the news these days without hearing the doom-and-gloom message of market volatility: Returns are sinking, prices are dropping, and you, my investor friend, are losing money.
It’s not a pretty picture they’re painting.
But if loss is your first thought when you see a dip in stock prices, you might need to change your perspective. If you’re in the accumulation stage of your financial journey, the thing you really need to focus on is the number of shares you own and staying diversified.
The Fluctuation Formula
When you see a pullback in your investments—be it in your 401(k), IRA, or other account—look at it as a fluctuation rather than a loss.
Let’s use your hypothetical 401(k) as an example. If you’re contributing regularly but your latest statements don’t show growth, look a little closer. While it may not show positive returns, there is still a reward for your faithful investments.
Let’s say you contribute $100 every week, and shares are $10. That means that every week, you’re purchasing ten shares. If there’s a pullback and prices drop to $8 a share, and you still contribute that same $100, that means you get 12.5 shares instead of ten that week. Add the ten shares from the week prior, and you now have 22.5 shares. That means when prices bounce back to $10 a share, your shares will be worth $225—whereas, if you had continued to invest at the “normal” price—when returns were positive—you would only have $200 worth of shares at the end of those two weeks.
It’s like a closeout sale, and you get to purchase a bunch of discounted merchandise—except that later, the store reopens, and shoppers are willing to pay you full price for what you bought on sale.
So, a pullback isn’t a net loss—it’s your opportunity to buy more shares for less money.
consistency is key
Of course, most people don’t have the time or desire to watch the market and jump in only when prices are low (you have a job, a family, a life, after all). Instead, we leverage a strategy called dollar-cost averaging, which is a jargony way of saying you pay the average price of shares by investing consistently rather than trying to guess the highs and lows of the market and buy low, sell high.
This is why people do so well with 401(k)s—it’s an easy, set-it-and-forget-it way to invest consistently. It’s also an incredibly important strategy when your goal is to accumulate money over a long period of time.
Even if you stop adding to the account for one reason or another, you can re-invest the dividends and continue to purchase more shares, which will benefit you in the long run.
The Diversification Principle *
That said, there are no guarantees in the stock market. Crises do happen; companies go bankrupt (my fellow Atlantans have Enron as a prime example). But that’s why we diversify. When you invest in different companies and sectors, you spread that risk around—so if one company fails, it’s not taking your entire portfolio with it. Diversification helps protect you from such an extreme risk.
If you’re not sure how diversified your investments are, reach out to your advisor and find out. A well-balanced portfolio is one of the keys to bouncing back during times of market volatility.
* Diversification does not assure a profit or protect against market loss
The least-effective investment strategy
Even understanding all this, it can be difficult to see market volatility as an opportunity when the media frames it as a crisis—which is why it’s important to remember that media outlets are businesses, and their goal is to make money. And they do that by gaining listeners. And people listen when they are afraid.
If you’re afraid of losing money, you’re going to pay attention to what’s happening in the market. You’re going to watch, listen, or click again tomorrow to keep tabs on the disastrous story that is the American economy. You might even let this fear guide your investment decisions and start pulling out of the market (emotions being the least reliable investment strategy).
Contrarily, if you have confidence that you’ll recover from the inevitable and intermittent ups and downs of the market, you might spend your time reading a book, going outside, playing with your dog, or doing just about anything other than watching the news.
Their job is to keep you hooked. Your job is to maintain perspective.
I’ve been in this industry more than 25 years, and the reality is, even with frequent pullbacks in the daily market cycle, the long-term impact of this kind of volatility is usually pretty negligible.
Doing what’s best for you
Your other job as an investor is to know your limits and decide on an investment strategy that works for you. When I talk with clients about volatility, we discuss specifically how much fluctuation they’re comfortable with—because there will always be fluctuation in the market, and you have to be honest with yourself about how much you can handle. Otherwise, you may commit to a strategy that’s too aggressive for you and end up making an emotional decision later that knocks you off course.
If market fluctuations make you super uncomfortable, that’s totally fine—it’s better to know your limits and choose a strategy you can commit to, one that aligns with your risk tolerance and goals. That’s what I help my clients do—because that’s how you get your best possible rate of return.
