Tips for Handling Market Volatility

For investors lulled to sleep by the market's relatively smooth ride earlier this year, the last few weeks have been a rather rude awakening. From Oct. 8-16, the Dow Jones Industrial Average lost nearly 900 points, its worst drop since a plunge of more than 1,000 points in late January-early February. And while on a percentage basis those totals represent drops of only about 5% and 6%, respectively, the recent volatility has been enough to remind investors that the market sometimes moves down--and fast.

By midday Friday, the Dow had erased more than half of its recent losses. But investors are still left to wonder, once again, if we're in the midst of a long-overdue correction (the last one taking place in 2011) or even the start of a bear market (the last one ending in early 2009).

With this in mind, we decided to ask Morningstar readers on our Personal Finance discussion board about their tricks for weathering market volatility. Some saw the recent market upheaval as an opportunity to buy stocks on sale while others said it had convinced them to pull back on their allocations to equities. Still others said they ignore market volatility, preferring to take the long view of market performance. You can read the full conversation here.

The Buyers
Many readers said that steep downturns represent buying opportunities as stocks suddenly go on sale.

JohnnyG said his approach during such times is to "hold my nose and keep buying."

Another reader, tradinggoddess2, explained her strategy as follows: "At the time of greatest fear, I try to invest in something. I add to my equity mutual funds.  Also, I review my wish list for the best bargain due to overblown fears and spend a little. This action meets my need to do something. In general, I am glad I did a year later."

Some readers felt that the market's recent downward moves were overdue and welcomed a return to valuations they see as more reasonable.

"The market's been overvalued for a while, so I bought more of my losers when they went 'on sale' recently," wrote Lorraine10. "That was hard to do, but I did it. All solid companies with decent dividends. I'm comfortable with those buys. ... Went over my holdings and made specific decisions on what to do if I think the next dip is the beginning of a bear market so I can act quickly and without emotion or panic."

But not everyone was so confident about how to react to the market's recent ups and downs.

"Tricks? What tricks? Wish I had some," wrote Bobert42. "It's a sure bet that someone is making money on this volatility and it sure isn't me. I want to know what their tricks are."

Reader srercrcr used the recent dip in prices to substantially reallocate his or her portfolio.

"I went from 60% invested (on the equity side) to 100%," srercrcr wrote. "Even though there are cross-currents, conditions for business growth remain."

Even some readers who typically ignore market volatility were enticed to act, such as w004dal.

"Over the past 11 years, I've been sticking to my game plan to use diversified (mostly index) funds and avoid individual stock picks," the commenter said. "However, the post-[quantitative-easing] era seems different and requires a different approach. I've been using around 1% of my portfolio for short-term volatility hedging with  iPath S&P 500 VIX Short-Term Futures ETN . While I'm not a huge fan of the fund, I haven't found anything better, and it does provide some buoyancy, provided I don't hold it for too long."

Others said that taking advantage of volatility is just one piece of their long-term investing plans.

"No tricks, just intensify my 'long game eyes'/10-year focus. More so if a significant drop occurs [as in 2008], when I'll then review my plan more often and before the compulsion to act takes over," said longameyes. "I hold 5-10% in cash for a contrarian buy list that fits my plan; could be more aggressive buying of what I already own or start of a new position I'm considering. ... Fortunate to buy plenty in 2009-10."

As Nittwit put it, "Volatility brings opportunity. I keep a watch list of equities I would like to own. ... If volatility brings down the cost of some of the equities I follow I can purchase them from my cash holdings."

Several readers referenced the 2008 market meltdown and said that, by comparison, the recent upheaval seems like little more than a small bump in the road.

Inspectorgadget summed up his or her approach to recent market volatility this way: "Nibbled a bit on downtrodden equity investments across the board. Otherwise unperturbed. This isn't 2008. But [I am] holding a small amount of investable cash in case there's another hiccup in the next few months." 

Others also said they are preparing for more volatility to come, and more chances to buy stocks at good prices.

"Any pullbacks at this juncture present a buying opportunity that doesn't come around all too often," said bleggard. "I have been adding to my long-term small-cap fund,  Royce Special Equity (RYSEX), which has doubled in the last six years. I also will be adding to my long-term international fund,  Dodge & Cox International Stock (DODFX), on any down draft of 10% or more as Europe weakens. I'm not hoping for any long downward spiral, but I am looking to add value while it's here. Also, I will be adding to my holdings in emerging markets by allocating some monies to Seafarer Overseas Growth and Income (SFGIX), which I have owned for almost a year and half."

DBSMichigan described how he or she prepares for market downturns and provided a dose of perspective on recent market movements.

"Prior to the recent modest pullback I wasn't seeing bargains, so rather than reinvesting dividends and capital gains I had been letting them accumulate in brokerage account money markets," DBSMichigan wrote. "When I saw support build last week, I bought a couple of large-cap ETFs--since that's where the correction was concentrated. In general, though, I limit my market-timing behavior to risk preference rotation; more aggressive after the market has tanked in a major way and more conservative as the market cycle matures and valuations get progressively higher. This recent pullback was really modest--still a lot of support and lots of cash still on the sidelines. So, no reason to migrate toward a higher risk profile. Looking forward to a decent year-end rally, though."

Then there was Rathgar, who said market volatility is to be expected.

"If you expect corrections and bear markets you won't be surprised when they come," the commenter said. "On average, I expect the following: 5% declines a few times a year, 10% [declines] annually, 20% [declines] every four years. This is the price you pay for higher returns."

The Sellers
But while many saw the recent volatility as an opportunity to buy, others, including MPodracky, saw it as a signal to sell.

"I am 61 and have been retired for 3 1/2 years," the commenter wrote. "The recent market volatility made me re-think my asset allocation. I lowered my stock weighting from 58% to 51%. This is still considered moderately aggressive in the glide paths of target-date funds. Now my cash position equals three years of living expense."

Tbeatty had a similar take, writing, "I don't have the kind of cash flow (salary) to put new money into the market if stocks continue to decline. However, I did liquidate lots of equity positions in my IRAs, where there are no tax consequences. The market just wasn't making sense anymore: up 2% one day, down 2% the very next day. I am in a waiting position to put that money back. Meanwhile, I still have nearly 50% in equities (I had over 80% in equities before, and I just couldn't stomach the volatility)."

Those Who Keep Calm and Carry On
However, if there was one prevailing sentiment regarding market volatility among readers, it was to not panic.

"Ignore the noise, literally," advised marymary. "The days the market's been at its wildest, I don't even look and occupy my time with other activities. I focus on the long term and the fact that my portfolio income won't change even though portfolio value may be down temporarily."

"We have two tricks," wrote xBanker. "1. Walk away from the computer. 2. Pour a high-quality scotch."

Juris2 said he or she takes a close look at the causes of volatility and cautions not to act in haste.

"I've learned over time that it's best not to take actions quickly in response to news," Juris2 wrote. "I have built in a hesitation or delay. At the same time I don't believe that most market movements are random, even if they are unpredictable because so many different factors affect market performance. I try to study and understand what's going on for when it's time to make investment moves or major changes in my asset allocation."

Taylor Larimore, a founder of the Bogleheads community of investors who favor the low-cost, index-based style pioneered by Vanguard founder Jack Bogle, provided his own take on the subject.

"At the age of 90, I have many years of experience with market volatility," Larimore's posting reads. "1. I have learned that stock-market volatility is normal and should be expected. 2. Portfolio volatility is best controlled with bonds, CDs, or other fixed-income assets. I simply keep the percentage of fixed-income assets equal to what I cannot afford to lose. It lets me sleep like a baby. 3. After determining a suitable stock/fixed-income ratio, stay-the-course. "

Tomas47, who retired in 2003 at the age of 56, offered similar advice.

"I have lived through some volatile times, and while it is concerning, it has not been traumatic," he wrote. "I have spent much study time developing my asset allocation table with 5% rebalancing ranges. That provides the discipline to help stay cool during extreme periods. In fact my advice to my kids that will eventually be managing the portfolio is to 'sit on your hands' during these periods."

Another reader extolling the virtues of proper asset allocation was FingerlakesGuy. He wrote, "Honestly, I don't think that there should be any 'tricks' once market volatility has arrived. If you haven't positioned your portfolio to the correct allocation that you can sleep with at night before the volatility occurs, then you probably need to rethink your investing strategy. I keep my allocation steady, except with the 'cash' (mainly a stable-value account paying 3%) that, depending on how far the markets decline, I may invest more into equities. Other than that, I allocate at 60/40, rebalance no more than every 6 months (usually annually), and just don't look at my portfolio when the market is in flux. Oh, and I try not to read the prognosticators, bull or bear. It's really an effort in futility to get too bent out of shape over what either has to say."

Several readers mentioned that using dividend-focused strategies helps them weather market ups and downs.

"My portfolio is mostly dividend growth, and the dividends keep coming even when the market gets a hiccup," said wenzela. "What goes up will come down, and the other way around. I keep some dividend cash for buying opportunities during downs."

There also were those readers who offered more philosophical takes on how to ride out market volatility. One was FidlStix, who wrote, "Market volatility is like flies and mosquitos. It'll always be with us, more in some seasons than others. Annoying, but no reason to re-route a walk in the woods."

OldDog said he weathers market turbulence through "a portfolio designed for moderate risk at our stage of retirement with enough short-term [cash] and dividends so we are not forced to sell anything to cover expenses. Quality, low-expense funds for equities and bonds. No longer trading; letting the 'experts' do it for us. Using our time to enjoy life and our friends. The stock market does not move in a straight line, so pullbacks, corrections, whatever you call them, are just a part of the game. Have not watched TV or CNN in years. I prefer to be outside in the forest with the dogs."

Comments have been edited for clarity and brevity.