Combat market volatility with these long-term investment principles

Image1Market volatility and economic uncertainties are inevitable during your investment journey. Instead of frantically inspecting your portfolio when unsettling news makes you anxious, it's best to trust your overall investment strategy.

Ideally, this plan should be crafted with your long-term objectives in mind, grounded in principles that align with your unique risk tolerance to help tolerate stress. While each investor's strategy may vary, if you focus on these three well-established principles and ignore discouraging headlines, you can prepare yourself for a more optimistic financial future.

What is market volatility?

Before we dive into three key long-term investment principles, it’s helpful to understand what market volatility entails. Market volatility refers to fluctuations in the prices of financial assets — including stocks, bonds, or commodities — within a specific period. These price changes can be caused by various factors like economic news, investor sentiment, or geopolitical events. High market volatility signifies greater uncertainty and risk, while lower volatility suggests a more stable and predictable market environment.

1. Understand that uncertainty is truly inevitable

Keep in mind that uncertainty and economic volatility are longstanding aspects of investing. When considering events from the past three years alone — such as the global COVID-19 pandemic, rising inflation rates, and persisting concerns about recession — it might have appeared that there were ample causes for alarm. However, the events of the past three years underscore the importance of enduring short-term fluctuations and remaining committed to your investment strategy.

This is where thinking about your long-term goals and risk tolerance becomes a key player in your approach to investing. It requires being completely honest with yourself. Are you the kind of person who will feel anxious when the market takes a sudden drop? Do you feel a need to react as soon as a concerning headline comes forth about a recession? If so, then you should consider opting for a more conservative portfolio rather than choosing aggressive and volatile investments.

2. Include diversification in your initial investment plan

As you map out your investment strategy, another thing to consider aside from your risk tolerance is how diversified your portfolio is. Thanks to financial innovations in the past century — exemplified by mutual funds and ETFs — the majority of investors can now access broadly diversified investment strategies at exceptionally low costs.

Ensuring that your portfolio is well-diversified serves as a powerful defense against economic uncertainty for several compelling reasons. It reduces risk by spreading investments across various asset classes, lessening the impact of poor performance in a single company, industry, or country. This strategy lowers volatility, enhances stability, and promotes long-term growth. Most importantly, it provides peace of mind, ensuring that your financial future isn't overly reliant on a single investment or asset class, thus encouraging commitment to long-term financial goals during economic turbulence.

3. Attempting to time the market is not a sound strategy

When circumstances take a downturn and news reports suggest trouble ahead, some investors contemplate timing the market. The notion of employing short-term tactics to evade immediate losses while still capturing long-term profits can be alluring, but extensive research consistently shows that such timing approaches are unproductive. The consequences of making mistakes in your timing strategy can outweigh any apparent advantages.

It's not uncommon for many investors to feel like they need to make adjustments to their portfolios as the market runs its course. Dramatic news headlines and expert predictions often amplify these sentiments with pessimistic outlooks. Nevertheless, for long-term investors, preparing for potential outcomes by solidifying their long-term strategies holds greater efficacy than attempting to forecast specific events.

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Written byDimensional Fund AdvisorsContributing writer

Dimensional is a recognized global investment advisory firm that positions itself as a bridge between profound academic financial research and practical investment solutions.