What to do when the markets are volatile and uncertain

Needless to say, investing during periods of market volatility can be unsettling. No one likes to see their account value dip—even temporarily. However, there are a time-tested set of principles you can follow that can help you stay focused on your long-term goals and navigate through the near-term choppiness to potentially smoother waters.

Living through a bear market can be a difficult experience, but it inevitably happens. The US equity markets have entered their 10th bear market since 1965. On the other hand, over the same period, we also experienced nine bull markets. While the average bear market has lasted an average of just 13 months with about a 29% decline in the S&P 500^®, the typical bull market has lasted much longer and led to much higher returns—an average of 56 months with an increase of 178% in the S&P 500^®. So don’t get anxious; try to keep everything in perspective. Remember that, historically speaking, the markets have gone up for much longer periods of time than they’ve gone down, and the magnitude of the upward moves have tended to be significantly greater than the downward ones.

It generally doesn’t pay to try to time the market. Disciplined investors who hold a diversified mix of investments through both good times and bad typically earn higher returns than those who try to repeatedly buy and sell. It boils down to emotions. Anxiety often results in making the wrong investment decision at the wrong time. As an example, in March 2009, the Dow Jones Industrial Average hit a low of approximately 6600. It had been as high as 14,000 not long before and yet most investors were looking to sell as the market went down. If you ask investors about what they are looking for to get back into the market after a drop, the answer you often hear is, “I am waiting for the market to go back up!” Unfortunately, many investors end up buying high and selling low, exactly the opposite of what they should be doing. Additionally, many investors that try to time the market end up missing the boat once the recovery starts to happen.

We can’t stress this one enough: having a diversified portfolio is critical during a market downturn. Choosing a mix of stocks, bonds, and cash with specific weightings (i.e., your “asset allocation”) may help dampen the fluctuations of your portfolio. That’s because historically, different asset classes have tended not to move in lockstep—for example, when stocks dip, bonds may rise, and vice versa. Of course, the right mix of assets for you will depend on your goals, timeframe, and risk tolerance.

It’s also important to rebalance periodically as the different holdings in your portfolio change in value relative to each other. Rebalancing simply means returning your portfolio back to its original asset allocation percentages. This is done by selling any overweight asset classes (those that have risen in value) and buying the underweight asset classes (those that have fallen in value). Not only does rebalancing help keep you aligned with your long-term investment strategy, it also automatically encourages you to buy low and sell high. What’s more, rebalancing may result in higher cumulative total returns with less volatility than a portfolio that’s not rebalanced.

During turbulent periods, having a concrete, long-term financial plan can give you peace of mind and instill confidence. Markets will go up and down, and you will likely experience several major declines over several decades. Knowing when those ups and downs will happen or how long they will last is impossible. So as a long-term investor, you are probably better off just ignoring the noise and staying focused on your financial roadmap. A well-crafted plan will be designed based on your timeframe and risk tolerance, and it will help ensure that you are not exposed to too much (or too little) risk. A recent study has shown that over the long term, financial planning may deliver significant value—ranging from an additional 1.59% average annual total return per year for retirees to 3.00% per year or more for other investors.

There’s no reason you have to face market uncertainty alone. E*TRADE from Morgan Stanley offers an array of online tools and resources to help you choose investments and build a diversified portfolio. We also offer Core Portfolios to help you navigate the markets.