When investing, the market experiences ups and downs, and it’s important to be prepared for losses because you'll almost certainly experience them at some point.
Understanding market volatility
If you're new to investing, know the market moves in cycles. Sometimes up, other times down. This is referred to as market volatility. It’s unpredictable and different factors can contribute to it, ranging from inflation to global events.
When volatility occurs, it might resolve quickly or linger for weeks or even months. Higher volatility means more risk while lower volatility may mean a less risky market environment. As an investor, there's little you can do to control market volatility — but you can control your reaction to it.
Read more: Take this quiz to help you choose which Ally Invest accounts are for you
How investors react to losses
If volatility is on the rise, here are three strategies available to you:
Sell: If stock prices start to tumble, selling puts the brakes on losses. But when market volatility increases and stock prices drop, panic selling can happen. Selling in this scenario might mean you lose money in the long run, if the stocks you sold off rebound.
Buy: If you're able to set aside emotion, you may consider buying more stocks when prices drop. If volatility eases, and prices climb again, you could later sell and reap the benefits. But know you’ve taken on more risk, since there is no guarantee the stocks will recover (or that they won’t continue to drop, resulting in losses).
Hold: When you hold, you're taking a wait-and-see approach to see what happens. If volatility eases relatively soon after a drop, then any losses you realize may be quickly erased by gains. If the stock continues to slide, you could decide it's prudent to sell.
The dangers of emotional investing
Volatility can be stressful, so it's easy to give in to emotional investing. When managing losses in a portfolio, it’s important to make thoughtful decisions. Here are a few emotional biases to be aware of:
Loss aversion: The goal is to avoid further losses. You may end up holding onto a stock that’s losing money rather than selling it, in the hopes of regaining its value.
Overconfidence: When you assume you know more about the markets than you do, you may end up overestimating a stock’s return potential, which can lead to disappointment and even selling at a loss.
Endowment effect: Creates an emotional mindset in which you hold on to assets because you think they’re worth more than what they are
When you have a plan of action and a diversified portfolio, you’ll be better equipped to take (or not take) next steps during times of volatility.
Building a strong foundation to help manage losses
Losing money isn't pleasant. But the more attuned you are to your appetite for risk and investing goals, the easier it becomes to navigate volatility. And when you have a plan of action and a diversified portfolio, you’ll be better equipped to take (or not take) next steps during times of volatility.
Solidifying your goals
Having a solid objective for investing can help you stay focused through times of volatility. Understanding your risk tolerance and having strong goals (and timelines for each) can help you better understand the impact of any potential losses. Then, any adjustments you choose to make can still be in service of your goals.
Gauging your comfort zone
Establishing a baseline or upper limit for acceptable losses can help you decide whether it makes sense to sell, buy or hold. Yours can depend on several things, including your personal trading strategy, your investment time horizon and your risk tolerance.
Note: An Ally Invest Robo Portfolio may be the tool for you if you’re nervous about navigating volatility. Because your portfolio is managed for you, there's less likelihood of emotion creeping in and causing you to sell off assets in a panic when the market experiences a downward turn. You can also choose to have a cash buffer to add some padding to your portfolio.
Read more: Is a robo or financial advisor in line with your investing needs?
Managing through loss
The market will go up and down, but what’s important is what you do during those swings. You can minimize loss by developing an individualized approach to your investing, based on the financial outcomes you’re aiming for. The volatility may still be stressful, but your investing strategy can help you ride the wave.
