373: 5 Ways to Handle Volatility

Learn what to do when the stock market is volatile.

The stock market pulled back 1600 points in one day.

A new record.

I saw one TV reporter make a big deal of a 500 pt drop because that's what happened in the crash of 1987. Percentage-wise that was a 22% decline vs. a few percent.

Yesterday the Dow dropped 567 then gained 567. Don't pay attention to the number of points it moves, pay attention to percentages. Now that the Dow is so much higher at 25,000, it would take a drop of 5,500 points to equal 22% like in 1987.

Stock market pull backs, and crashes, are part of investing so you need to have a strategy to handle them.

Rather than hoping they won't happen, you have to accept them as part of investing and learn what to do because the stock market drops about 10% every 11 months on average.

The Dow Jones Industrial Average has dropped 20% 12 times since the end of WWII. That's about every 6 years.

You have 3 choices whenever there is volatility:

Buy, hold or sell.

Since there are bigger corrections every 6 years, that is the best time to buy. It will also feel the most scary. People will move from complacency to panic. It's just how it works.

You can hold for the long-term. It's good to make sure your asset allocation is where you want it to be. If you are going to need the money in less than 2 years, then you may want to be aware of how much risk you are taking. Is it the right amount?

You usually don't want to sell, because there are dead-cat bounces that happen after a large decline. Panic selling is never a good idea.

So your options are really hold or buy.

If you're dollar cost averaging like in your 401k, then you are buying regularly and automatically. It's common for funds to invest at the end of the month, and if the market is a little lower than the month before, then you will buy lower.

Start to think opposite of the crowd. Watch the sentiment indicators. They poll investors and tell us whether they are optimistic or bullish or pessimistic or bearish and what percentages are which.

Usually if 60% are optimistic bulls, then the market will pullback and get a little fear back.

Fear is actually good because markets are said to climb a wall of worry. When too many people are expecting it to move higher, it's like everyone is on one side of a boat and you know what happens then.

More volatility happens until the fear comes back into the market and some move to the other side of the boat.

So here are some things to think about:

1) Is your asset allocation (percentages in small, mid, large, etc.) correct for your age and circumstances? The younger you are, the more you want in stocks.

2) Are you keeping a long-term view?

3) Volatility is part of investing. Usually the best thing to do is nothing. Just ride it through, unless you want to buy.

4) The only thing that will help is time, so give it time to work it's way through.

5) Expect pullbacks, they are normal and eventually end.