Market Volatility Strategy
The term market volatility strategy refers to the approaches investors can take when the market is rising or falling in relatively short timeframes. Market volatility strategies start with the construction of investment portfolios that match the individual's risk profile.
A market, or industry, is said to be volatile when it is rising or falling in relatively short timeframes. Typically, statisticians will state volatility in terms of the standard deviation of an investment's return. The standard deviation measures the range of returns around the average; therefore, larger standard deviations mean more volatility. For example, the returns associated with the stock market will have a larger standard deviation than those of a money market fund.
While sudden increases in the value of a portfolio are welcomed by an investor, a sudden downturn can be worrisome. There are several ways to lower the risk of a portfolio; however, the most important step is to build one that matches the investor's risk tolerance score. Other strategies include:
- Diversification: includes building a portfolio that includes equities (common stock), fixed-income securities (bonds), as well as stable value investments. Diversification also includes owning securities across a number of industries.
- Investing Over Time: also referred to as dollar cost averaging, this strategy involves purchasing securities over relatively long timeframes. This can sometimes be accomplished through regular payroll deductions.
- Bond Laddering: involves the purchase of fixed-income securities with staggered maturity dates. Laddering helps investors to manage interest rate risk, and provides them with the opportunity to make a series of reinvestment decisions over time.