If you're like many travelers, you get a little nervous when your airplane goes through some turbulence. And if you're like a lot of investors, you may get somewhat jumpy when the financial markets are volatile. Yet flight turbulence probably isn't as scary as it seems, and the same may be true for market volatility — if you know how to respond.
Let's look at some positive responses to market movements:
•Don't overreact to turbulence. Turbulence happens on most flights, but passengers are well aware that they can't "bail out" at 30,000 feet, so they generally don't panic. As an investor, you also need to avoid panicky behavior — by not taking a "time out" from investing. Over a period of decades, if you were to miss just a handful of the market's best-performing days, your returns could be dramatically reduced. And the best days often follow some of the worst. So if you're not invested in the market, you could miss out on the beginning of a new rally, which is typically when the biggest gains occur.
•Balance your "cargo." The ground crew properly positions an airplane's cargo to maintain the plane's center of gravity and reduce the effects of turbulence. When you invest, you also need to achieve balance by owning a variety of vehicles, including stocks, bonds, government securities and certificates of deposit. You'll want your investment mix to reflect your risk tolerance, goals and time horizon. While this type of diversification can't guarantee profits or protect against loss, it can reduce the effects of "turbulence" — that is, market volatility — on your portfolio. Over time, your "cargo" (your investments) may shift, becoming too heavy in stocks or bonds relative to your objectives. Consequently, you'll need to periodically rebalance your portfolio to ensure it's meeting your needs.
•Match your "transportation method" with your goals. If you are flying from New York to Los Angeles, you may experience delays or some changes in the flight plan — but your goal is still to reach Los Angeles as quickly and efficiently as possible. Consequently, you wouldn't scrap the idea of flying and head to the West Coast on foot. When you invest, you will also encounter events, such as market downturns, that you feel may be slowing you down in your progress toward your long-term objectives, such as a comfortable retirement. But if your objectives haven't changed, neither should your "transportation method" of reaching them. In other words, don't abandon your long-term strategy in favor of quick fixes, such as chasing after "hot" stocks that may not be suitable for your needs.
•Maintain perspective on your "flight path." When you've flown, you've probably observed (perhaps with some envy) some of your fellow passengers sleeping through periods of turbulence. In the investment world, these types of people are the ideal long-term investors — they know that turbulence, in the form of market fluctuations, is normal, because they've experienced it many times before. Their perspective isn't on short-term events, such as volatility, but rather on the voyage toward their "final destination" — i.e., the achievement of their long-term goals.
So when you fly, fasten your seatbelt and relax. And when you invest, don't overreact to short-term events. By following these basic guidelines, you will be a calmer traveler and a better investor.