So, you thought we'd put the volatility from the first quarter in the rearview mirror? Well, think again!
Last week, the iconic Dow Jones Industrial Average shed nearly 400 points on Tuesday, rebounded by more than 300 points on Wednesday, and then gave 252 points back on Thursday. That's three consecutive days where one of the world's most-watched indexes vacillated by more than 1%. Meanwhile, the CBOE Volatility Index, a measure of investor fear, which hit as low as 12.29 on Friday, May 25, surged to as high as 18.78 last week.
Some folks would view this step-up in volatility as a reason to make for the sidelines. But, truth be told, that's probably the worst thing you could do. With volatility back in full force, here are four things you should do right now instead.
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1. Relax, and realize that stocks go down, too
To begin with, it's important for investors to realize that stocks do indeed head in both directions. As much as we'd like stocks to just keep going up and making us money, it simply doesn't work that way. According to data aggregated by Yardeni Research, the broad-based S&P 500 (^GSPC +0.64%) has undergone 36 corrections where it's lost at least 10% from a recent high since 1950. That works out to one correction about every two years.
While we're on the subject, it's also worth pointing out that it's impossible for investors to know ahead of time when these corrections will occur, what precisely will cause them, how long they'll last, or how steep the decline will be. Trying to predict any, or all, of these variables is usually what gets investors into trouble.
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2. Understand that extended downside moves are often short-lived
Next, investors should be aware that while downside moves in the stock market are common, they rarely last very long. Of those aforementioned 36 stock market corrections, just seven have lasted in excess of a year, and only two of those seven corrections have occurred over the past 36 years. Another seven corrections have lasted between four months and a year. This means that 22 of the 36 corrections in the S&P 500 have run their course in fewer than four months.
Cumulatively, the S&P 500, per Yardeni's data, has spent 7,040 calendar days in correction since 1950. However, it's spent nearly three times as many calendar days in a bull market. In short, while the downside moves in stocks are often swift and rife with emotion, they historically give way to long-lasting bull markets.
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3. Reconsider your investment thesis for the stocks you own
Another smart thing you can do when stock market volatility picks up is reassess your investment thesis for each and every stock you own. To be fair, you don't have to wait until there's a stock market correction before you dig into your existing holdings, but it's often a good wake-up call for investors who've put their portfolios on autopilot.
The question you'll want to ask when reviewing your portfolio is this: "Does the reason I bought into this stock in the first place still hold water?" In other words, you want to dissect what, if anything, has changed in the underlying business model of the companies you own stock in. If nothing has changed, and your investment thesis still makes sense, then there's no reason to panic and run for the hills. If, however, your original investment thesis has shifted, it may be time to sell your stake.
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4. Consider adding to new or existing positions
Finally, investors should consider using volatility to their advantage. As noted, it's impossible to tell when a correction will occur, how long it'll last, or how far the stock market could decline. Nevertheless, history has shown that corrections of virtually any magnitude are a good time to buy stocks. With the exception of the latest correction, all 35 previous corrections in the S&P 500 have been completely put in the rearview mirror by bull market rallies. Though nothing in the stock market is a given, 35-for-35 is about as guaranteed as you're ever going to get.
In particular, it's never a bad idea to consider adding to existing positions where your investment thesis still holds water, or to consider buying new equities. Dividend stocks can be of particular interest during a volatile market. Dividend stocks tend to have time-tested business models, can help modestly hedge against short-term downside in the stock market, and can be instrumental in helping to grow wealth if those dividends are reinvested back into more shares of dividend-paying stock.
Ultimately, a volatile market is a time for opportunity, not for fear.
