Why is the stock market so volatile right now?

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Conversations about the stock market are usually tied to comments about its volatility — how frequently share prices go up and down. The choppy nature of share prices can be intimidating to some investors, especially those who are just beginning to invest, nearing retirement, or have been burned by volatility in the past.

Stocks are considered an important part of an investment portfolio and can be a tremendous source of wealth-building for investors. And while there are some lower volatility equities versus higher volatility ones, it’s undeniable that they are a turbulent asset class. That’s why understanding volatility is key to being a good stock investor.

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Related: How rising inflation affects mortgage rates

What Is Stock Volatility?

Volatility in the stock market occurs when there are big swings in share prices. Share prices can change quickly for a multitude of reasons. And while volatility in the stock market usually describes significant declines in share prices, volatility can also happen to the upside.

Volatility is often synonymous with risk for investors. That’s because investors generally prefer a steady source of returns rather than an erratic one.

However, volatility in the equity market can also represent significant opportunities for investors. For instance, investors might take advantage of volatility to buy the dip, purchasing shares when prices are momentarily lower.

Recommended: What Types of Stocks Do Well During Volatility?

How to Measure Stock Volatility

Investors often measure an investment’s volatility by its standard deviation of returns compared to a broader market index or past returns. Standard deviation is a calculation determining the extent to which a data point deviates from an expected value, also known as the mean.

A low standard deviation indicates that the data points tend to be close to this expected value. Therefore, an investment with a low standard deviation is considered to have low volatility. A high standard deviation indicates that the data points are spread out over a larger range. For investments, a high standard deviation generally translates to high volatility.

Investors can also monitor the risk in their stock holdings by finding their portfolio beta – its sensitivity to price swings in the broader market. Beta is the financial risk that stems from the entire market and can’t be diversified away.

Another popular measure of tracking volatility is the Cboe Volatility Index, otherwise known as the VIX. The VIX measures the short-term volatility of the U.S. stock market via a formula that uses options trading or the price of call and put contracts based on the S&P 500 Index.

What Causes Market Volatility?

The stock market is known for having boom-and-bust cycles, which is another way of describing volatility.

Long periods of booming share prices tend to drive investors to take on more risk by entering into more speculative positions and buying riskier assets; investors and traders don’t want to miss out on the rally. They thus make themselves more vulnerable to shocks in the financial system, leading to market busts when investors need to sell their holdings en masse when the market is shaky.

Recommended: What Is Flight to Quality?

Regarding individual stocks, events tied to the company’s performance, such as earnings or a product announcement, can drive volatility in its shares. But when it comes to broader market volatility, various causes can trigger more significant swings in share prices, like changes in economic policy or uncertainty over geopolitical events.

For instance, the early stages of the coronavirus pandemic in February and March 2020 brought shockwaves into the markets. As economies across the globe shut down, investors began to sell off risky assets, bringing about high levels of volatility in the financial markets. Governments enacted extraordinary fiscal and monetary stimulus programs to calm this volatility and bring stability to the markets.

Other factors that can drive volatility include liquidity and the derivatives market. Liquidity is the ease with which an asset can be bought and sold without affecting prices. If an asset is tough to unload and gets sold at a significantly lower price, that could inject fear into the market and cause other investors to sell, ramping up volatility.

Separately, there’s sometimes a debate whether derivatives — contracts that are based on an underlying asset — can cause volatility. For instance, in 2020, investors debated whether large volumes of stock options trading caused sellers of the options, typically banks, to hedge themselves by buying stocks, exposing the market to sudden ups and downs when the banks had to purchase or sell shares quickly.

How to Manage Volatility When Investing

Let’s pretend that it’s 2007, and an investor has money invested in the U.S. stock market. Unfortunately, this investor is facing one of the largest stock market crashes in history. The S&P 500 fell by 57% during this crash.

This drop in the stock market isn’t typical, but it can be traumatic even for the savviest and most experienced investor. So the first step to handling stock market volatility is understanding that there will be some price fluctuation. The second step is to know one’s risk tolerance and financial goals, then invest and readjust a portfolio accordingly.

Generally speaking, higher rewards sometimes come with higher risks. For example, younger investors in their 20s might want to target high growth and be open to more volatile stocks. The reverse is true for someone approaching retirement who wants stable portfolio returns. Some strategies a more cautious investor can take to mitigate volatility in their portfolio. One way is diversification.

Here is why portfolio diversification matters: lower volatility stocks, such as utility or consumer staple companies, can add stability to a stock portfolio. Meanwhile, energy, technology, and consumer discretionary shares tend to be more turbulent because their businesses are more cyclical, or tied to the broader economy.

Another way to diversify one’s portfolio is to add bonds, alternative investments, or even cash. When deciding to add bonds or stocks to a portfolio, it’s helpful to know that the former is generally a less volatile asset class.

How Much Stock Volatility Is Normal?

The average stock market return in the U.S. has been 10% annualized over time. But 10% is an average — share prices returns can be much higher or lower. For example, as measured by the S&P 500, equity prices closed out 2008 down 38%. Then, in 2009, they rallied by 23%.

Past performance is not indicative of future returns, but looking at history can help an investor gauge how much volatility and market fluctuation is normal. Since World War II, the S&P 500 has posted 12 drops of more than 20%. These prolonged downturns of 20% or more are considered bear markets.

The table below shows the S&P 500’s returns from the highest point to the lowest point in a downturn. According to this data, bear markets average a decline of 34%, lasting a little more than a year. Bear markets have occurred as close together as two years and as far apart as nearly 12 years.

Historic bear markets

The Takeaway

Stock volatility is the pace at which the market moves up or down during a certain period. It’s a complex topic that often sparks debate among investors, traders, and academics about what causes it. While equities are considered an important part of any investment portfolio, they are also known for being volatile, and some degree of turbulence is something most stock investors have to live with.

However, for long-time investors, periods such as when the dot-com bubble burst in the early 2000s and the financial crisis in 2008 are defining moments when market volatility seemed to get out of hand. While such events are rare, investors should make sure to diversify their portfolios, monitor the share prices of their stock holdings, and seek protection when possible.

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This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.


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6 ways to protect your money from inflation

6 ways to protect your money from inflation

Inflation has been squeezing — and infuriating — U.S. consumers for a long time now.

What began as an annoyance (an extra pinch at the gas pump and the grocery store) has turned into a painful reminder that budgeting and saving may be even more important than anyone ever thought. And without a plan to deal with inflation’s effects — day to day and over time — your dollars can lose purchasing power.

The good news is that it’s never too late to consider strategies that could protect your money from inflation, while also keeping in mind your personal financial situation, your goals, and your tolerance for risk.

Read on for intel on how to protect your money and yourself from inflation.

Related: What is wealth management?

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Wondering what inflation is exactly? In basic terms, inflation means prices are rising and your purchasing power is declining. You can’t get the goods and services you’re used to buying without paying more for them. And if your income doesn’t increase to match those higher prices — because you can’t get a pay raise that keeps up, or you’re a retiree on a fixed income — it can really impact your lifestyle.

The U.S. has been on a months-long run of record-setting inflation since the start of the coronavirus pandemic. And according to the U.S. Department of Labor Statistics, it’s the costs most people can’t avoid — like food, gas, and rent — that are driving the continued increase in the Consumer Price Index (the most commonly used measure of inflation).

It’s true that there are common causes of inflation and escalating prices aren’t uncommon, but what is happening right now is undoubtedly intense. Rates are hitting the highest numbers the U.S. has seen since the early 1980s, which means it’s the first time many consumers here have experienced inflation at this level. 

But even a low inflation rate can erode purchasing power over the long haul. For example, according to the U.S. Inflation Calculator, if you purchased an item for $100 in 2000, that same item would have cost $150.30 in 2020 — before inflation soared. The dollar had an average inflation rate of 2.06% per year in the two decades between 2000 and 2020, producing a cumulative price increase of a whopping 50.30%.

That’s why preparing for inflation can be an important consideration for every consumer, whether you consider yourself a saver, a spender, an investor, or (like most people) you’re a mix of all three.

Recommended: Is Inflation a Good or Bad Thing for Consumers?

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Needless to say, stuffing your money into a mattress or cookie jar probably isn’t the best strategy for protecting your hard-earned dollars.

Not only is an FDIC-insured savings account generally considered a safer place to keep your funds, but you also can earn interest on your money until you need it. Perhaps you’re saving for a down payment on a car or home, a wedding or vacation, or maybe for an unexpected expense.

Although most savings accounts pay minimal interest — usually not enough to counteract even low inflation rates — you’re at least earning something. And if you take time to occasionally review the interest rates various financial institutions are offering, you may be able to improve on what you’re currently getting.

For example, online financial institutions are more likely to offer high-yield savings accounts than traditional brick-and-mortar banks. So, if you’re comfortable with the idea of electronic banking, you may find a significantly higher annual percentage yield (APY). You also might be able to reduce or eliminate some of the fees you’re paying, which can boost your savings as well.

If the Federal Reserve continues to raise its benchmark interest rate in an effort to combat inflation, as it has indicated it will, you may see the rate on your current savings account slowly increase. But if it doesn’t, or if you don’t want to wait around for that to happen, it may make sense to start shopping for a smarter way to save right now.

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Taking the time to reassess the potential earnings from your savings account can be an important step in offsetting inflation’s impact on your bottom line.

 But there are other strategies you also may want to consider. Here are steps that can help you protect yourself from inflation.

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It might be hard to believe when the housing market is this hot and prices are this high, but homeownership actually may help protect you from inflation.

If you’re a renter, you’re probably at the mercy of your landlord when it comes to how much your monthly payment could go up when it’s time to renew your lease. And during an inflationary period, your landlord may decide to raise your rent to reflect higher prices. If you decide to move, your new lease also could reflect the high inflation rate. Plus, you’ll have to go through the hassle of finding a new place and moving.

If you buy a house, on the other hand, you’re more likely to have a fixed monthly payment that’s locked in for the life of your mortgage. Another benefit: The value of the home you own may increase along with inflation. And if you hang onto your home until it’s paid off, you won’t have to worry about what housing prices (renting or owning) might look like in the future.

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Especially if you’re a first-time homebuyer, you might feel more than a little overwhelmed thinking about signing off on a 30-year fixed-rate mortgage for, let’s say, $350,000.

It might help to take a deep breath and think about this: According to the U.S. Inflation Calculator, $350,000 in today’s dollars is equal to about $173,000 in 1992 dollars. Thirty years ago, somebody thought $173,000 was a crazy-high amount of money for a house. Now, it sounds like a bargain. It often takes us by surprise how prices (and salaries) do rise over the years.

If you’re borrowing money for 30 years (the most common mortgage term) at a competitive interest rate — and you aren’t paying more than the home’s appraised value — inflation could work for you. That’s because the value of money, including debt, declines as the inflation rate rises. So, the inflation-adjusted value of your mortgage payments goes down as inflation and your property value go up.

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If you have the room and a knack for bargain-hunting, it may make sense to build up a supply of the kinds of goods that could be affected by inflationary prices. This is especially those items that are often linked to shortages.

Unfortunately, it isn’t really feasible for most folks to stockpile gasoline. But your backup supply might include canned goods, baby food, paper towels, toilet paper, and other necessities that you find on sale or can buy for less in bulk.

Keep in mind, though, that if you pay for those goods with a high-interest credit card and you don’t pay off the balance each month, you might not see any savings. (Which is another good reason to keep some money stashed in your checking and savings account to pay for such purchases.)

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The price of durable goods (products that typically last at least three years) also can be affected by shortages and increased consumer demand.

If you need a new car, for example, and prices seem high for the make or model you want, it may be tempting to purchase a lower-quality replacement. Keep in mind, though, that over the long term, you could end up spending more on repairs than you would have if you bought the better brand. Or the less expensive make may not last as long as a better car would have.

You may find it’s a smarter strategy to get an auto loan and invest in the higher-priced car from the start.

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household budget can be a helpful tool any time, but it could be particularly useful when prices are soaring.

Even if you already have a budget, you may want to reevaluate your spending in categories that are or could be vulnerable to inflation, such as food, transportation, healthcare, and utilities. And you may have to look for categories you can spend less on (at least temporarily), such as entertainment, dining out, clothing, and vacations.

If you’ve put most of your bills on autopay, you also can check for “expense creep” on things like cable and Wi-Fi, subscription services, and utilities.

Sticking to a budget could help you avoid touching your emergency savings when times are tight—or, worse, overusing high-interest credit cards.

Once you’ve established a savings account (hopefully a high-interest one) for your emergency fund and other short-term expenses, you may want to look at investing as another strategy to combat inflation.

Though it carries more risk than keeping your money in a high-yield savings account, investing in stocks, mutual funds, or exchange-traded funds (ETFs) can help you grow your money for the future.

Once again, let’s go back 30 years to get some perspective. According to Officialdata.org’s S&P 500 data calculator, if you had invested $100 in the S&P 500 at the beginning of 1992, you’d come out with about $1,974.20 at the end of 2022 (assuming you reinvested all dividends). That’s a return on investment of 1,874.20%, or 10.42% per year. Even after adjusting for inflation, you’d be looking at a 7.87% return per year — which is better than most alternatives. Which all goes to say that investing may be a very good hedge against inflation.

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What is the best way to protect against inflation?

The best approach may be to prepare for the worst while hoping it doesn’t happen. This means finding ways to get the most for your money as a saver (perhaps with a savings account that pays more in interest), spender (adopting a budget and savvy buying tactics), and investor (with investments that keep growing your money over time).

Where should I put my money to combat inflation?

You may want to start by shopping for a savings account that offers a higher APY and/or lower fees. That way, you won’t be slowly losing money as your cash sits in the bank. Another option is to invest it, which is riskier but may yield you a higher return.

How can I prepare for hyperinflation?

You can use many of the same tactics to protect against runaway or hyperinflation as you would for high inflation. You might decide to stockpile goods now, while your money has value, for example. You may choose to buy a car or make another important purchase sooner rather than later. You also can evaluate what expenditures are “needs” vs. “wants” and budget appropriately. Also try not to panic — which can lead to poor decision-making.

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To younger consumers, today’s high inflation may seem like a new phenomenon. But inflation always has been — and always will be — a challenge.

While you probably can’t avoid inflation completely, with proactive planning, you may be able to blunt its impact on your day-to-day and long-term finances. If you haven’t already, you may want to review your savings, spending, and investing strategies to be sure you’re getting the most you can for your money.

Learn More:

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.


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