October 18, 2024

The Impact of Volatility on Your Portfolio

What is Market Volatility?

Market volatility refers to the rate at which the price of an asset or a market index fluctuates. It can be driven by factors including economic news or sudden changes in investor sentiment. It is difficult to track down the cause of volatility in the same way it is difficult to explain or predict the market. The best thing you can do about it, is to mitigate its risk of negatively impacting your portfolio. Especially volatile markets can experience sharp price increases or decreases within a short period, which can increase uncertainty and fear among investors.

While some volatility is normal due to the regular market fluctuations, extreme market swings can erode the value of your investments, especially if they occur consistently.

How Volatility Impacts Your Portfolio

Erosion of Returns

During periods of high volatility, the value of investments can decline rapidly. If you are forced to sell during a downturn, you could lock in losses that might be difficult to recover from. The Figure below depicts the effect of erosion on a portfolio due to volatility. The green line demonstrates an investment with consistent returns while the grey line demonstrates an investment with higher volatility which causes inconsistent returns. The 20-year value of the investment with consistent returns has an ending value that is nearly $2 million more than the investment with inconsistent returns. This represents the way volatility can erode the value of your investments.

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Emotional Decision-Making

Volatility often leads to panic among investors, causing emotional decisions. It could cause you to reactively sell or buy investments that do not align with your long-term goals.

Increased Portfolio Risk

When volatility rises, so does the risk of significant losses. Without proper diversification or risk management strategies in place, your portfolio may be more exposed to these risks than you realize.

Hindering Long-Term Goals

If volatility isn’t properly managed, it can derail your long-term financial objectives, such as retirement, education funding, or wealth preservation. Volatility can blind people from forward-looking market perspectives, causing you to only think of the short-term when making investment decisions. This can eat into returns, reducing your portfolio's ability to grow and meet your future needs.

Why Mitigating Volatility is Important For Financial Success

Protecting Wealth

By incorporating strategies such as diversification, hedging, and strategic asset allocation, you can help reduce the impact of short-term market swings and work to protect your wealth over the long term. It can help protect from the erosion of wealth that volatility can cause.

Promoting Steady Growth

Reducing volatility in your portfolio can allow for more consistent returns. This helps your portfolio to maintain a better chance of compounding returns and assists you in working towards your financial goals without the setbacks of large losses.

Maintaining Peace of Mind

When volatility is well-managed, it’s easier to stay the course. Investors with a clear plan can ride out market turbulence without making impulsive decisions, helping them remain on course for their long-term solutions.

How to Mitigate Volatility

There are several strategies that can help you reduce the effects of market volatility on your portfolio:

1. Diversification

Spreading your investments across different asset classes (stocks, bonds, private and alternative investments) and sectors can help limit exposure to any single market or economic event. By holding a mix of asset classes, the negative performance of some investments can be offset by the positive performance of others, leading to more stable overall returns. While diversification doesn’t eliminate risk entirely, it can significantly reduce the volatility of your overall portfolio and protect against the potential for large losses in an investment portfolio.

2. Regular Rebalancing 

Over time, various assets will perform differently, which can lead to an unintended shift in your asset allocation. Rebalancing your portfolio helps it stay aligned with your risk tolerance and financial goals. This process can also prevent overexposure to certain investments, preventing them from becoming too large a portion of your portfolio.

3. Investing in the Long Term

Focusing on long-term investments can help mitigate the impact of short-term market volatility. The longer you hold an investment, the higher potential benefits you can experience from compounding returns. Reinvesting earnings can potentially enhance your total return, helping to offset short-term volatility.

4. Professional Guidance

Working with a wealth manager can provide expert insight into strategies that best fit your risk tolerance and financial objectives, helping you navigate volatile markets with confidence.

Conclusion

Volatility is an unavoidable aspect of investing, but with proper risk management, you can mitigate the negative impact it could have on your portfolio. Understanding how volatility affects your investments and implementing strategies to reduce its risks will help safeguard your financial future and keep you on track toward achieving your goals.

If you’re concerned about how market volatility could affect your portfolio, our wealth management team is here to help. Contact us today learn how to protect your wealth from the ups and downs of the market.

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