Market Volatility

An Investor's Guide To Market Volatility Knowing what to do during a market downturn can be especially difficult in the moment. Here’s how to plan ahead. In 1 minute When the prices in financial markets change, that’s market volatility. More volatility means greater potential for both gains or losses. In investing, market volatility comes with the territory. Some days the market is up, and other days it’s down. It’s OK to be anxious during a dip, but preparing for market volatility can help you avoid making decisions out of fear. Two of the biggest ways you can prepare for volatility: Diversify your portfolio Build an emergency fund Diversification helps protect your portfolio by spreading out your risk. A diversified portfolio may not gain as much as some individual assets, but it likely won’t lose as much as others. An emergency fund is a financial safety net. If market volatility negatively impacts your investments, your emergency fund can help cover your expenses until the economy recovers. During a downturn, we recommend resisting the urge to change your investments. Give your portfolio time to recover. But if you can’t do that, try to keep changes small, like lowering your stock allocation so that it’s more consistent with a more conservative risk tolerance level. In general, you should invest for the long-term, but at the same time you’ll likely want a diversified portfolio that you’re comfortable holding on to even when things in the market get bad. This can increase the odds you remain in the market when it ultimately recovers and continues on its path of expected long-term growth. Still not satisfying the itch to act? High management fees or capital gains distributions (from a mutual fund) could make that market volatility more uncomfortable. Or perhaps your financial advisor isn’t sticking to your target allocation as your portfolio experiences gains and losses. In these situations, a lower-fee robo-advisor like Betterment can help alleviate that discomfort. In 5 minutes In this guide, we’ll cover: What market volatility is How to prepare for it What to do about it Nobody likes to see their finances take a nosedive. But in a volatile market, dips happen often. Market volatility refers to fluctuations in the price of investments. Some markets—like the stock market—fluctuate more than others. And in times of economic stress, markets tend to be even more volatile, so you might see some big ups and downs. It’s tempting to sell everything and bail out during dips, but that often does more harm than good. Selling your assets could lock-in losses before they have a chance to rebound from the dip, and it’s nearly impossible to predict the market’s high points and low points. Reacting to market drawdowns by moving to cash is like selling your clothes because you gained a few pounds. Sure, they may feel a little snug, but you could find yourself with a bare closet if and when your weight fluctuates the other way. Historically, the stock market has had plenty of bad days. In any given decade, you’re bound to see many drawdowns, where investment values dip frightfully low. But when you step back and look at the big picture, the market has trended upward over time. So far, the global stock market, and by extension the U.S. stock market, has always recovered from economic downturns. And while nothing in life is guaranteed, those are some pretty good odds. History shows us that experiencing short-term losses is part of the path to long-term gains. The key for investors is to expect market volatility. It’s inevitable. And that means you need to prepare for it—not simply react to it. How to prepare for market volatility Market volatility can occur at any time. So you want to be ready for it now and in the future. The main thing you can do to prepare is diversify your portfolio. Having a balance of different assets decreases your overall level of risk. While some of your assets momentarily struggle, for example, others may hold steady or even thrive. The goal is your portfolio will hopefully feel less like a rollercoaster and more like a fun hike up wealth mountain. Beyond that, you’ll want to strongly consider building an emergency fund. A good starting point is having enough to cover three to six months of expenses. This is money you want on hand if market volatility takes a turn for the worse. Even if you don’t depend on your investments for income, major economic downturns can affect your life in other ways. The poor economy could lead to layoffs, bankruptcies, and other situations that impact your job stability. Or if you have rental properties, the real estate market could be adversely affected as well. All the more reason to have an emergency fund and ride out that turbulence if the need arises. What investors should do during downturns Caught in a downturn? Don’t panic. Seriously, when the market looks grim, the best reaction is usually to do nothing. Selling off your portfolio to prevent further losses is a common investor mistake that does two things: It locks-in those losses It takes away your chance to rebound with the market Scratching an itch usually won’t prevent it from recurring. The same goes for reacting to short-term losses in your portfolio. As much as you can, you want to resist the urge to react. Still, sometimes you may feel like you have to make a change. If that’s you, the first thing to do is make sure you’re comfortable with the level of risk you’re taking. Some asset classes, like stocks, are more volatile than others. The more weighted your portfolio is toward these assets, the more vulnerable it is to changes in the market. You’ll also want to confirm that your time horizon (when you need the money) is still correct. Think of this like checking your pulse, or taking a few deep breaths. You’re making sure your investments look right—that everything is working like it’s supposed to. If you’re still feeling tempted to do something drastic like withdraw all your investments, you probably should reduce your level of risk. Even if everything looks right for your goals, making a small adjustment now could prevent you from making a bigger mistake out of panic later. Your pulse is too high. Your breaths are too rapid. Sitting at 90% stocks and 10% bonds? You might try dialing it down to 75% stocks and 25% bonds. The time may be ripe to consider a Roth conversion Our investing advice of doing nothing and staying the course is generally the direction we try to nudge you toward when markets are down. While drops in global markets can be stressful, they also provide opportunities that can be beneficial for future you. One of those strategies is implementing a Roth conversion. A Roth conversion allows you to transfer, or convert, funds from a traditional IRA to a Roth IRA. You will typically owe income taxes on the amount you convert in the year of conversion, but the tradeoff is that once inside the Roth IRA future growth and withdrawals are generally tax-free. You can take a look at other pros and cons of Roth conversions in our Help Center.  Here are a couple of reasons why you may want to consider converting your IRA when the market is down:  The balance of your Traditional IRA has dropped significantly. When the balance of your Traditional IRA drops, you’re able to convert the same number of shares at lower market prices. This means you may pay less in taxes than if you converted those same number of shares at higher market prices. Growth from a global market recovery can be better in a Roth IRA than a Traditional IRA. As global markets recover over time, the value of your converted holdings may increase. This increase in value will now take place in your Roth IRA. Down the line, when you start taking withdrawals out of your Roth IRA in retirement, you’ll be able to do so without incurring any taxes. To understand how a Roth conversion may impact your personal financial situation, we strongly recommend consulting a tax advisor and IRS Publication 590. Betterment is not a licensed tax advisor and cannot provide tax advice. Reassess where you invest Depending on your situation, another option might be to shift your investments to a financial institution like Betterment. This could save you money in other ways, which might make your current risk level feel more comfortable. Some signs this might be the right move for you: 1. Your accounts have higher management fees You can’t control how the market performs, but you don’t have to be stuck with higher fees. Switching to a lower-fee institution like Betterment could lead to less of a drag on your long-term returns. 2. Your allocation is incorrect The sooner you need to use your money, the less risk you should take. Not sure what level of risk is right for you? When you set up a financial goal with Betterment, we’ll recommend a risk level based on your time horizon and target amount. 3. You own mutual funds that pay capital gains distributions When a mutual fund manager sells underlying investments in the fund, they may make a profit (capital gains), which are then passed on to individual shareholders like you. These distributions are taxable. Even worse: mutual funds can pay out capital gain distributions even if the fund’s overall performance is down for a year. So in a volatile market, your portfolio could lose value and you may still pay taxes on gains within the fund. In contrast, most exchange traded funds (ETFs) are more tax efficient.

How Betterment Anticipates Market Volatility—So You Don’t Have To It’s difficult to endure volatile markets when it affects your investment portfolio. Betterment has automated features in place to help address volatile markets when they occur. If you’ve ever been told to “sit tight and stay the course” when the market is dropping and your investment account is worth less than it was just moments ago, you’re not alone. Financial advisors, including Betterment, love this mantra and repeat it anytime there’s a market downturn—which every investor should be prepared to navigate at some point. But being told to do nothing when your account balance is dropping can feel like an inadequate response. And, unless your investment strategy has been designed from the ground up to anticipate and react to market volatility, you may be right. The reason Betterment advises our customers not to react or adjust their investment strategy during a market downturn is because our entire platform was designed with inevitable downturns of the market in mind. This article will cover how our investment portfolio creation process, ongoing automated account management system, and dynamic advice are designed with market fluctuations in mind, so that you can “sit tight and stay the course” and feel confident it’s actually the right thing to do. Our portfolios are constructed with market volatility in mind Betterment’s portfolio construction process strives to design a portfolio strategy that is diversified, increases value by managing costs, and enables good tax management. Ultimately, our goal is to help you build wealth. This means: Our intent is to create portfolios designed to have a better chance of making money and a lower chance of losing it. At a baseline, our allocation recommendations are based on various assumptions, including a range of possible outcomes, in which we give slightly more weight to potential negative ones, by building in a margin of safety—otherwise known as ‘downside risk’ or uncertainty optimization. So, even before you’ve invested your first dollar, your portfolio has already been designed to account for the market fluctuations you will inevitably experience throughout the course of your investment journey, including situations like the big downturns like 2008 and the more recent market crash in 2020. Furthermore, our risk recommendations consider the amount of time you’ll be invested. For goals with a longer time horizon, we advise that you hold a larger portion of your portfolio in stocks. A portfolio with greater holdings in stocks is more likely to experience losses in the short-term, but is also more likely to generate greater long-term gains. For shorter-term goals, we recommended a lower stock allocation. This helps to avoid large drops in your balance right before you plan to withdraw and use what you’ve saved. All you have to do is: Tell us what you are saving for (your investing goal). Let us know how long you plan to be invested (your time horizon). We take care of the rest. By using your personal assumptions, in conjunction with our general downside risk framework, we’re able to recommend a globally diversified portfolio of stock and bond ETFs that has an initial risk level recommended just for you. Our automated portfolio management features keep you on track during downturns How we construct our globally diversified portfolios and the risk framework we apply to each investor’s specific allocation recommendation is just the starting point. It’s our ongoing and automated portfolio management that provides an additional value-add, especially in times of heightened volatility. Our automated features like allocation adjustments over time, portfolio rebalancing, tax loss harvesting for those who select it, and updated advice when you need it, can help keep your investing goals on track during a downturn. Automated Allocation Adjustments When we ask you to tell us about your investment objective, including how long you plan to be invested for, it helps us choose the appropriate asset allocation for you throughout the course of your investment time horizon, not just in the beginning. For most Betterment goals, we usually recommend that you scale down your risk as your goal’s end date gets closer, which helps to reduce the chance that your balance will drastically fall if the market drops. This is an especially important consideration for an investor who plans to use their funds in the near term. We call this recommendation “auto-adjust” or a goal’s “glidepath”—a gradual reduction of stocks in favor of bonds. And instead of leaving this responsibility up to you, you can opt into our auto-adjust feature in eligible portfolio selections, which means our system monitors your account and adjusts your portfolio’s allocation automatically over time. Automated Portfolio Rebalancing Normal stock market fluctuations will likely cause your actual allocation to drift away from your portfolio target, which is calculated to be the optimal level of risk you should be taking on. We call this process portfolio drift, and though a small amount of drift is perfectly normal—and a mathematical certainty—a large amount of drift could expose your portfolio to unwanted risks. When the market fluctuates, not all of your investments are shifting to the same degree. For example, stocks are generally more volatile than bonds. As you can imagine, a period of sustained volatility could mean a significant shift in how your portfolio is actually allocated, relative to where it should be. Left unchecked, this drift could be harmful to your portfolio’s performance, which is why at Betterment our portfolio management system provides ongoing monitoring of your portfolio in order to determine whether rebalancing is needed. While we generally use any cash inflows, like deposits or dividends, and outflows, like withdrawals, to help rebalance your portfolio organically over time, when a significant market drop occurs, there might be a need to sell investments that have appreciated and buy investments that have depreciated, in order to adjust your portfolio back to its optimal allocation. Consider an instance where the value of your stock investments has dropped significantly and now your bond investments are overweighted relative to your stocks. Our rebalancing system might be triggered to correct the drift. Not only would our automated rebalancing seek to ensure your portfolio’s allocation is realigned relative to its target, it would also mean buying stocks at their currently cheaper price point, setting you up nicely for any market recovery. Furthermore, if effective rebalancing does require selling investments in a taxable account, the specific shares to be sold are selected tax-efficiently. This is designed with the aim that no short-term gains are realized. We never want the tax impact of maintaining proper diversification to counter the benefits of applying our risk framework. Automated Tax Loss Harvesting Tax Loss Harvesting is a feature that may benefit you most when the market is volatile. After all, if there aren’t any losses in your account, we can’t harvest them. Our automated TLH software monitors your account for opportunities to effectively harvest tax losses that can be used to reduce capital gains that you have realized through other investments in the same tax year. This can potentially reduce your tax bill, thereby increasing your total returns, especially if you have a lot of short-term capital gains, which are taxed at a higher rate than long-term capital gains. And, if you’ve harvested more losses than you have in realized capital gains, you can use up to an additional $3,000 in losses to reduce your taxable income. Any unused losses from the current tax year can be carried over indefinitely and used in subsequent years. Keep in mind, however, that everyone’s tax situation is different—and Tax Loss Harvesting+ may not be suitable for yours. In general, we don’t recommend it if: Your future tax bracket will be higher than your current tax bracket. You can currently realize capital gains at a 0% tax rate. You’re planning to withdraw a large portion of your taxable assets in the next 12 months. You risk causing wash sales due to having substantially identical investments elsewhere. Our dynamic financial advice works for you during market fluctuations Much like the automated features described in the section above, the advice we give our customers is dynamic and updates automatically based on many factors, including market performance. Just as your car’s GPS recommends the best route to take to reach your destination, Betterment recommends a tailored path toward reaching your financial goals. And just as the GPS updates its recommended route based on road conditions and accidents, we update our advice based on various circumstances, such as a market downturn. In addition to recommending a starting risk level tied to your specific objective, we also estimate how much you need to save. In the case of a really big market drop, we might advise you to do something about it, such as make a single lump-sum deposit, which will help keep your portfolio on track. Recognizing that coming up with sizable excess cash can be tough to do, we’ll also suggest a recurring monthly deposit number that may be more realistic. And, if it’s early on in a long-term goal, it’s unlikely you’ll need to change anything significantly, because you still have a lot of time on your side. Conclusion The path to investment growth can be bumpy, and negative or lower than expected returns are bound to make an investor feel uncertain. But, staying disciplined and sticking to your plan can pay off. Betterment’s investing advice has been purpose-built with all the worst and the best the market may throw at us in mind by focusing on three key elements: intentional portfolio construction, automated portfolio features, and advice that reflects market conditions. Feel confident that Betterment’s hard at work, for you, so that you can truly sit tight and stay the course.