Volatility in U.S. stocks ramped up again on Tuesday, with the S&P 500 index dropping another 2.6 percent. It's been quite a while since investors have dealt with this level of market volatility, and plenty of portfolios are deeply in the red since October.
Fortunately, there are simple ways investors can protect their portfolios during periods of market volatility. There are five easy tips for long-term investors to help navigate a volatile market.
-- Sell some of your stock.
-- Hedge your bets through diversification
-- Look for bargains in the market.
-- Don't worry about daily swings.
-- Keep things in perspective.
Sell Some of Your Stock
If you are losing sleep at night over stock market volatility, it may be a red flag that you have too much money in the stock market. No person should invest more money in the stock market over the short term than they are willing to lose. There is no such thing as a guaranteed investment, but selling stocks and putting the money into less volatile bonds or even certificates of deposit can help eliminate some of the stresses of market volatility.
DataTrek Research co-founder Nicholas Colas says volatility can serve as a helpful reminder to keep your market optimism in check. "Price volatility tests human hope, and risk management is essentially the mechanism of containing hope's most damaging effects," Colas says.
Hedge Your Bets Through Diversification
There are plenty of strategies for investors to hedge against unexpected spikes in volatility. The iPath S&P 500 VIX Short-Term Futures ETN ( VXX) is a fund that tracks the CBOE Volatility Index, which increases in price along with market volatility. The VXX ETN is up 37 percent since Oct. 1, and investors who used it as a hedge have offset at least part of their losses. Other popular ways of hedging stock holdings include inverse exchange-traded funds and buying put options.
Given the Russell 2000 index is down 14.6 percent over the past three months compared to just a 6.7 percent decline by the S&P 500, Colas says there is a potential hedge trade in small-cap stocks. "If you want a hedge, short the S&P 500 against the small caps," he says.
Look For Bargains in the Market
Periods of market volatility can provide excellent opportunities to buy high-quality stocks at a discount. In early 2016, a period of market volatility related to concerns about China's economy drove Amazon.com ( AMZN) stock from $696 down to $474. Investors who didn't panic and took advantage of the buying opportunity watched the stock quadruple to above $2,000 over the next three years.
Daniel Ives, managing director of equities research at Wedbush Securities, says he has seen a number of investors looking like deer in the headlights in the past few months.
"In our two decades of covering tech stocks on Wall Street, dislocations and sell-offs like we have seen over the past few months represent unique entry points to own high quality secular tech winners and are not the time to waive the white flag, in our opinion," Ives says.
He recommends long-term investors take advantage of the dip and buy cloud and cybersecurity stocks, such as VMWare ( VMW), Qualys ( QLYS), Zscaler ( ZS), Microsoft Corp. ( MSFT) and Cyberark Software ( CYBR).
"The transformational cloud and cyber security trends are poised to see an inflection point in 2019, with strong spending trends and (merger and acquisitions) that should be a boost to the sector," Ives says.
Don't Worry About Daily Market Swings
If the daily swings in the stock market seem too chaotic and random to predict, remember that there's no reason to even subject yourself to daily market headlines. Assuming you have a long-term investment horizon of at least five years, chances are the current volatility will pass in a couple of weeks, months or, in a worse-case scenario, a couple of years.
Owen Murray, director of investments at Horizon Advisors, says long-term investors with well-balanced portfolios can essentially ignore the short-term noise in the market.
"Most individual investors position their portfolios to support their long-term financial goals, such as retirement or funding education expenses for their children or grandchildren," Murray says. "As long as you have confidence that the market will be higher years into the future, you shouldn't stress out about declines in the near term."
Keep Things In Perspective
Market pullbacks, corrections and even bear markets are a normal part of the stock market cycle. According to Guggenheim, since 1945, the S&P 500 has declined between 5 percent and 10 percent 78 different times. The average time it took to recover to its previous highs was only about one month.
"In the near term, the direction of the market is unpredictable, it can go higher or lower," Murray says. "But in the long term, markets generally move higher."