Ride out market volatility via diversified portfolio

by Richard A. Hale

for the Business Journal

Ten years after the market plunge of Oct. 19, 1987 what has become known as "Black Monday" the stock market took investors on another wild ride Oct. 27 with a 554 point drop in the Dow Jones Industrial Average.

Many analysts proclaimed that the correction was needed and the next day's 337-point rebound was reassuring. But, the dramatic events left many investors wondering what to do with their investments.

Regardless of the ups and downs of the market, over time the market generally trends upward. Investing for the long-term is one way to ride the market.

The following are more strategies to help investors stay calm during market fluctuations.

Diversify your portfolio. One strategy to help reduce your potential losses during a downturn in the market is to diversify your portfolio. Although many people believe that their portfolio is well-diversified if they have a lot of investments, that isn't necessarily the case.

A well-diversified portfolio is one that includes several different types of investments. A well-diversified portfolio in today's up-and-down market environment may comprise investments in bonds or high-quality bond mutual funds, in addition to your other investments.

Why is diversification important? A well-diversified portfolio may be protected from major trends in any direction. Because different markets often tend to move in different directions, having a variety of investments lends stability to a portfolio.

Another key to diversification is to make sure you don't have too much of your portfolio invested in the same sectors of the market. To further diversify, you may want to consider adding mutual funds to your portfolio the fund manager uses the pool of money to invest in diverse assets for you. You can further diversify by adding different kinds of mutual funds.

Dollar-cost averaging. Swings in the market are common, and trying to outsmart the market to sell before prices fall is a risk that may not work. Staying invested and dollar-cost averaging will help you more to automatically buy more when prices are low and less when they are high.

Here's how dollar-cost averaging works: Rather than taking a lump sum and dropping it into the market, you instead put a fixed amount into the market at regular intervals monthly, quarterly, yearly, whatever.

Keep in mind that dollar-cost averaging does not assure profits nor protect against loss in declining markets. But, it can be an effective way for the long-term investor to accumulate shares. However, investors need to consider their ability to continue investing during periods of low market prices.

Assess your personal risk tolerance. Be sure that your portfolio reflects the risk that you are willing to take with your investments. If you are a conservative investor, you may be more comfortable with low-risk investments like bank CDs. While CDs are FDIC-insured, you need to be aware that the return may not be as great.

And there is no such thing as an absolutely safe investment. If you have a higher risk tolerance, you should be able to withstand the fluctuations in the market.

Keep your expectations for returns realistic. Although we've experienced a bull market for many years, your expectations may be unrealistic about future performance.

As we have experienced, the market is volatile, and you need to be emotionally prepared for those ups and downs when they come.

Move into cash. A final strategy to reduce your exposure to volatility is to move some of your investments into cash and cash-equivalents. These investments won't pay spectacular returns if the market rises, but they won't decrease dramatically if it falls. Therefore, they may be a safe bet against a declining market.

A knowledgeable financial adviser can help you prepare a portfolio that meets your needs and help you enjoy a more comfortable journey on the wild ride of the market.

(Richard A. Hale, CFP, is a financial advisor with American Express Financial Advisors Inc.)

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