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Market volatility describes how markets tend to swing in value. It applies to any market that involves buyers, sellers and fluctuating prices, such as the housing market, stock market and cryptocurrency. Many different factors contribute to market volatility, but what matters most is understanding how it can affect your overall financial health.
Market volatility comes with the territory when investing, whether you're investing in stocks, buying a home or purchasing a car. Avoiding it completely may not be realistic, but you can take steps to soften the financial blow. In some cases, you might even use it to your advantage.
How Market Volatility Works
If there's one thing we know about global markets, it's that price movements are to be expected. Sometimes these fluctuations are gradual. Other times, they happen rapidly in response to any number of triggers.
The stock market is a prime example. When the coronavirus pandemic took hold, the S&P 500 fell by roughly 34% over the course of one month, but quickly rebounded to record highs. Lots of different factors can influence stock market trends, such as domestic politics, the economy, geopolitical crises and industry-wide news and developments that disrupt certain sectors of the stock market.
The housing market can be equally volatile, tending to bounce back and forth between favoring buyers and sellers. Available inventory, mortgage rates and economic changes can all drive housing prices up and down.
The last couple of years have been a wild ride for the housing market. Inventory reached new lows, with demand heavily outweighing supply. That, coupled with record-low interest rates, caused housing prices to surge.
Using Market Volatility to Your Advantage
Market volatility isn't always bad. In fact, you may be able to use it to your advantage. Selling shares when the market is up could translate to a nice return, and even a down market can present financial opportunities. Some see it as the best time to "buy at a discount" before prices go back up again. In theory, you could end up snagging potentially valuable stock while prices are dropping (though there's never any guarantee that stock prices will rebound in the future).
Volatility in other markets can also be beneficial. For example, used cars have been in particularly high demand since the beginning of the coronavirus pandemic. At the end of 2021, the average used car in the U.S. sold for $28,205, according to Kelley Blue Book—a 28% increase from the year before. A microchip shortage has contributed to a dwindling supply of new cars that seems to have fueled the uptick in prices. This shift wasn't great for those looking to buy a car, but it was welcome news for folks looking to trade in a used car—or sell one outright to the highest bidder.
And severe stock market swings can be hard to stomach, especially if you're watching your retirement account balances decline in real time. Fear can cause investors to react emotionally. While understandable, pulling your investments out of a volatile market can cut you off from future returns when the market eventually stabilizes again. Despite market volatility along the way, the S&P 500's average annual return from 2011 to 2020 was 14.4%, according to the American Enterprise Institute.
Minimizing the Effect of Market Volatility
Your long-term investment plan will be shaped by your individual goals, risk tolerance and retirement timeline. No matter what that looks like, staying the course is most important—even through bouts of volatility. Rebalancing your portfolio, or adjusting the weight of your different assets, may be a good idea as you go.
Here are some strategies that can help protect your investments from market ups and downs.
- Dollar cost averaging: With dollar cost averaging, you decide on a set amount of money, then invest that much in regular intervals. If you're contributing a fixed amount to your 401(k) every paycheck, you're already using this strategy. The idea is to invest the same amount regardless of market conditions. If the market goes up, you'll get less for your money; but during downturns, you'll be able to buy more shares. It can help take the emotion out of your investing plan.
- Diversification: Diversifying your investment portfolio can offer one of the best protections against market volatility. It involves spreading your money across a variety of different investments to help mitigate risk. If one section of your portfolio takes a hit, you'll hopefully have other investments performing well enough to pick up the slack. This usually involves mixing in safer investments like bonds, certificates of deposit and high-yield savings accounts.
- Investing for retirement early: A longer horizon gives your portfolio more time to bounce back from periods of market volatility. The best time to start saving for retirement is always now. Saving early and often also allows your nest egg to benefit from the power of compound interest.
The Bottom Line
Market volatility is a part of life and is nearly impossible to avoid. What matters most is minimizing its impact and finding ways to benefit from market swings whenever possible. Understanding how it all works can help strengthen your financial health. It's right up there with maintaining your credit. Experian lets you check your credit score and credit report for free whenever you want. It's one of the simplest ways to take control of your finances.