While the stock market has returned an average of 10% since 1926, it’s important to remember that those returns represent an average. Individual stocks can be quite volatile, especially for newer industries like marijuana or AI. Of course, there are also times when the entire stock market is volatile, such as during the 2008 subprime lending crisis.
Volatility can represent opportunities to make money, but it also means that you are at risk of losing quite a bit too. Fortunately, there are a few different strategies that you can adopt to weather a volatile market fluctuation.
Four Strategies to Weather a Market Fluctuation
Any investment comes with risk, and market fluctuations are a core part of the stock market. In fact, you can make a ton of money investing in volatile stocks if you put money in while they’re low and cash out when they’re up. Of course, if you want to reduce the amount of risk you’re exposed to, this probably isn’t a good idea: the strategies below offer a way to protect yourself against volatility.
1. Dollar-Cost Averaging
One of the best ways to grow your wealth through investing over the long term, especially during periods of high market volatility, is dollar-cost averaging. This is an investing strategy that dictates you put a set sum of money into a security at a regular interval. For example, you choose to invest $500 every two weeks (from every paycheck) into a stock.
Dollar-cost averaging means that you can take advantage of dips in the price of that stock. Effectively, you will buy more shares when prices drop and fewer shares when they rise. In the long term, this means you’ll end up with more shares than if you had put in a larger sum of money all at once.
Diversifying your investments is discussed so often that it’s approaching a cliche, but it’s an important strategy to weather market fluctuations. What may affect one sector or industry may not touch another one – or have a lessened effect. For example, the financial and auto sectors were hit hard in 2008, but alcohol sales stayed strong.
Investing in ETFS is also a good way to diversify without having to pick individual stocks yourself. ETFs are baskets of investments that are traded like stocks: they can have stocks, bonds, and other investments bundled together inside them. Having ETFs from different sectors is a low-effort way to hedge against volatility.
Diversifying can also mean looking at other investment vehicles. If you’re worried about volatile stocks, consider holding onto bonds or other low-risk investments.
3. Invest With Buckets
Another way to hedge against the risk associated with a volatile market is to divide your portfolio into buckets. Different buckets will be invested into different stocks and securities with separate risk profiles. You should divide your investments between short, medium, and long-term goals.
Your short-term savings, used for major purchases like home renovations or vehicles, should be in bonds and other low-risk investments. This way, you have little chance of losing your money, and you keep your funds liquid. Of course, this also means that you won’t make as much money with this bucket.
The next bucket should cover expenses that are more than a year away. Things like college funds would go into this bucket. You’d want to focus on relatively established stocks that pay high dividends, or higher interest rate bonds.
Finally, your last bucket should be focused on the long term. You can choose higher-risk companies that have a large potential for growth. This is where you can do your speculation and research into companies.
Of course, how much money you put into each bucket will depend on your goals. If you’re close to retirement, you aren’t going to be putting most of your money into the long-term bucket, for instance. As your goals change, you should rebalance how much of your portfolio is dedicated to each bucket.
Finally, the last strategy to consider when looking to build a stable portfolio is to take the dividends that you get from your investments and put them back into your portfolio. By investing your dividends, you can expand the impact of dollar-cost averaging and offset any downturns in the market.
The best way to do this is through a Dividend Reinvestment Program (DRIP) which will automatically reinvest your dividends into the security that paid them. This means that your portfolio will slowly grow on its own without you touching it.
DRIPs also allow for reinvestment without broker fees in most cases. By slowly and steadily growing the size of your investment, DRIPs are a great long-term strategy that can weather against sudden fluctuations in share price – especially for securities that pay dividends more than once a quarter.
Pick a Strategy and Stick to It
The important thing to keep in mind is that investing is a long-term game. A market fluctuation can create and wipe out a large amount of value quickly, but trends are what matter. Starting to invest now, and sticking with a strategy over the long term, will pay off eventually if you make smart decisions.
For more information about investing and building wealth, check out the Value 101 section of our website. It’s full of guides that can help you get started, no matter what your financial situation or goals are.