How to Handle Market Volatility

Market volatility doesn't appear to be going away — at least for now.

These are turbulent times. The war in Ukraine and China's zero-COVID policy have exacerbated global supply chain snarls, sending inflation higher. Today, investors worry as central banks debate how much — and how frequently — interest rates must go up to combat inflation.

To help make sense of the recent market volatility, we turned to Stu Kedwell, Senior Vice President and co-head of North American equities at RBC Global Asset Management, and Sarah Riopelle, Vice-President & Senior Portfolio Manager, Investment Solutions at RBC Global Asset Management. They shared insights every investor can draw on, including smart ways of thinking about volatility, how to manage emotions and what lies ahead.

Staying focused

Both Kedwell and Riopelle are advocates for taking a long view and seeing the bigger picture.

Kedwell believes it's always important to “maintain a long-term perspective" in the face of heightened volatility, saying that returns over a longer time horizon tend to stabilize. Market swings, he says, don't necessarily indicate that a 180-degree turn in investment strategy is required.

“Maybe you move to the slower lane for a period of time, but you don't get off the highway," he says.

As for keeping the big picture in mind, Riopelle says, “You want to put your money into the market based on a well thought-out investment plan."

Amid uncertainties, it may be tempting to forgo that plan and try to time the market. That, says Riopelle, can be “a recipe for disaster."

“To time the market, you'd have to get out at the top. And you have to also get in at the bottom," she says. “Even if you get one of those right, the chances of getting them both right consistently are extremely slim."

Understanding volatility

Kedwell reminds us that volatility is a reflection of markets trying to predict the future.

“Markets have a pricing mechanism that tries to sort out the odds of different outcomes. If the outcome of an odd goes from zero to five per cent, that still means it's unlikely. But the share price will factor that in to some degree," Kedwell explains.

Kedwell offers an analogy to explain.

“If you had a sign on your front lawn that said how much your house is worth at every minute of every day, right before a big storm is expected to hit, the market would knock that price down a little bit to try to account for the possibility, however remote, that something bad happens to your house." Kedwell says. Markets act in a similar way.

Check your emotions

When markets are choppy, it's important that investors check their emotions, says Riopelle.

“In the middle of volatility, or in the middle of crisis, is probably not the time to be making adjustments to your long-term investment plans," she says. “You want to make those changes in a calm environment."

“You can't control anything that happens in the markets, but you can control how you react," she adds.

“It's like watching a child grow up. They go through all sorts of ups and downs," Kedwell says of the recent market swings.

By definition, volatility measures the price fluctuations of an investment. While many people associate it with sinking markets, volatility also applies to price gains. Still, due to a phenomenon called loss aversion, most investors register losses more than gains.

All investments face varying degrees of volatility. Bonds are less volatile, while investors generally expect larger price swings in the stock market.

The 3 Ds

To mitigate risks, Kedwell explains how a three-D strategy may help investors ride through waves of uncertainty.

The first two Ds refer to diversification and dividends, strategies investors can explore to reduce risks. The third D is dollar-cost averaging, which involves investing a set dollar amount on a regular basis regardless of market conditions.

“For long-term investors, the decline can become your friend," Kedwell says of dollar-cost averaging. When markets decline, an investor could buy more units or shares with their set dollar amount, which lowers the average cost per unit.

Riopelle points to the value of holding various asset classes over a longer time horizon, given how certain investments move in opposite directions as market conditions change.

“Historically when stocks are going down, bonds are going up," she says, adding that diversification enables investors to have “a smoother return experience."

While both bonds and stocks have recently gone down at the same time, Riopelle says that's not unheard of over shorter timeframes. But over periods of three months or even a year, she says the negative correlation relationship persists the majority of the time.

Time-tested tips

For new and seasoned investors alike, Riopelle and Kedwell are quick to offer some of their best tips for keeping things in perspective when investing during volatile markets.

Kedwell says a trade journal — essentially a diary of past investment decisions — can help investors understand why certain trades were made, how they worked out and how they felt at the time. It's important to acknowledge that emotions can play a part, he says, and that mistakes can happen along the way.

One of Riopelle's best tips is one she shared recently with her own father, who contemplated selling his investments after a recent market downturn. “I understand your pain," she remembers telling her dad. “But if you sell now, you're locking in losses with no opportunity to make them back."

Her father stayed put, and later revisited his plan once markets bounced back from their lows. It's always better to make decisions from a position of strength, not weakness, she says.

What lies ahead?

The S&P 500 recently entered a bear market, with the index down more than 20 per cent from its high point in early January. Worries about stagflation — the combination of high inflation and low growth — have heightened as investors brace for economic headwinds. Talk of recession is gaining steam.

What will it take to curb market volatility?

Inflation will be key, both Kedwell and Riopelle say. Across advanced economies, central banks are caught in a bind. They want to cool inflation by raising interest rates — and therefore borrowing costs. But pulling the brakes too abruptly could risk tipping the economy into recession.

Riopelle expects market conditions will improve if central banks can engineer the so-called “soft-landing," defined as a cyclical economic slowdown where inflation is tamed enough without causing a recession.

Kedwell concurs. He anticipates volatility to persist as liquidity tightens. “This is a particularly difficult time for investors," he says. “Yet, these are the times that it's essential to have a good financial plan; one which accounts for the inevitable drawdowns along the path of long-term investment success."