Volatility Is Normal
Market volatility often feels alarming when you're experiencing it. Headlines amplify fear, portfolio values swing dramatically, and the urge to "do something" becomes intense.
Yet volatility is a normal feature of markets, not a bug. Understanding this intellectually—and internalizing it emotionally—is essential for long-term investment success.
What Causes Volatility?
Market prices reflect countless factors, and volatility arises when:
New Information Arrives
- Economic data surprises (positive or negative)
- Corporate earnings announcements
- Policy changes from governments or central banks
- Geopolitical events
Sentiment Shifts
- Changes in risk appetite
- Crowded positions unwinding
- Technical factors and momentum
Structural Factors
- Liquidity conditions
- Market structure and mechanics
- Seasonal patterns
The Psychology of Volatility
Our brains aren't well-designed for investment decisions during volatility:
Loss Aversion
Research consistently shows that losses feel roughly twice as painful as equivalent gains feel good. During volatile periods, we're hyper-focused on potential losses.
Sentiment Shifts
Structural Factors
The Psychology of Volatility
Our brains aren't well-designed for investment decisions during volatility:
Loss Aversion
Recency Bias We overweight recent events. After a sharp decline, it's hard to remember that markets have recovered from every previous decline.
Action Bias Uncertainty creates discomfort, and taking action—any action—can feel better than waiting. But in investing, the best action is often no action at all.
Narrative Seeking We crave explanations. Financial media provides them constantly, but most short-term market moves don't have clear causes, and many "explanations" are constructed after the fact.
A Framework for Clarity
When volatility strikes, return to fundamentals:
1. Revisit Your Goals
- Why did you invest in the first place?
- Have your long-term objectives changed?
- What timeline are you working with?
Most goals are measured in years or decades, not days or weeks. Short-term volatility rarely changes long-term outcomes.
2. Distinguish Signal from Noise
Ask: "Is there information in this price movement that should change my view?"
Most goals are measured in years or decades, not days or weeks. Short-term volatility rarely changes long-term outcomes.
2. Distinguish Signal from Noise
Often, the answer is no. Price declines don't necessarily mean underlying value has changed—they may reflect temporary sentiment shifts.
3. Consider the Full Range of Outcomes
Volatility creates both risk and opportunity. Prices can go up just as easily as down. If you sell during a decline:
- You lock in losses
- You need to decide when to re-enter
- You may miss the recovery
4. Check Your Portfolio Construction
Well-constructed portfolios should already account for volatility:
- Diversification across assets
- Position sizing appropriate to risk
- Liquidity for near-term needs
If volatility is causing significant stress, it may indicate portfolio construction issues to address—but not during the volatile period itself.
What History Teaches
Market history offers perspective:
Corrections Are Frequent
Markets decline 10% or more roughly once per year on average. Declines of 20% or more (bear markets) occur every few years.
4. Check Your Portfolio Construction
If volatility is causing significant stress, it may indicate portfolio construction issues to address—but not during the volatile period itself.
What History Teaches
Market history offers perspective:
Corrections Are Frequent
Recovery Is the Norm Every significant decline has eventually been followed by recovery. The timing varies, but the pattern is consistent.
Time Heals The longer your time horizon, the more volatility smooths out. Short-term returns are highly unpredictable; long-term returns are more consistent.
Missing the Best Days Is Costly Much of market returns come from a small number of exceptional days. These often occur during volatile periods. Missing them by being out of the market dramatically reduces long-term returns.
Practical Guidelines
During volatile periods:
Do
- Review your investment plan
- Ensure you have adequate liquidity for near-term needs
- Consider whether anything has fundamentally changed
- Talk to a trusted advisor if you're concerned
Don't
- Make impulsive decisions based on emotions
- Check your portfolio obsessively
- Try to time the market
- Assume this time is different
The Opportunity in Volatility
For long-term investors, volatility can be advantageous:
- Dollar-cost averaging works better in volatile markets
- Rebalancing naturally buys low and sells high
- Tax-loss harvesting opportunities appear during declines
- Entry points may improve for new investments
A Final Thought
Volatility tests our discipline. It separates investors who have a plan from those who don't, and those who can stick to their plan from those who can't.
The discomfort you feel during volatile periods is real. But discomfort and danger aren't the same thing. Learning to tolerate the former while avoiding the latter is a core investing skill.
Markets will always be volatile. Your response to volatility is what you can control.
This article is for educational purposes only and does not constitute investment advice. All investments involve risk, including potential loss of principal.
Don't
The Opportunity in Volatility
For long-term investors, volatility can be advantageous:
- Dollar-cost averaging works better in volatile markets
A Final Thought
Volatility tests our discipline. It separates investors who have a plan from those who don't, and those who can stick to their plan from those who can't.
The discomfort you feel during volatile periods is real. But discomfort and danger aren't the same thing. Learning to tolerate the former while avoiding the latter is a core investing skill.
Markets will always be volatile. Your response to volatility is what you can control.
This article is for educational purposes only and does not constitute investment advice. All investments involve risk, including potential loss of principal.