How to use a diversified portfolio to navigate market volatility by Investing.com

The recent spike in volatility, highlighted by the (VIX)’s recent rise, is a reminder that market swings are an inherent part of investing, Wells Fargo strategists noted in a recent report.

However, the investment bank advises against reacting hastily to these fluctuations by reducing equity exposure, stressing the importance of sticking to a well-diversified asset allocation.

In short, strategists argue that volatility should not cause investors to exit the market or attempt to time it.

They point out that volatility is not exclusively associated with recessions; Booms can also occur, often in close proximity to recessions. The note points out that missing just a few of the market’s best days, which often coincide with periods of heightened volatility, can significantly reduce long-term returns.

“Furthermore, over the past 30 years, two of the three most recent bear markets have comprised nearly all of the worst 20 days and half of the best 20 days, further illustrating that the market’s best days come often when volatility is highest.” the ratio is specified.

In addition, the most significant market gains and losses frequently occur in rapid succession, particularly during periods of increased volatility related to economic downturns or bear markets. For example, between March 9 and 18, 2020, the market experienced two of its best days and four of its worst days in just eight trading sessions.

Wells Fargo further details the psychological biases that can influence investment decisions during volatile times.

Biases such as loss aversion, herd behavior and overconfidence can lead to harmful actions such as panic selling or overtrading. The strategies emphasize the importance of maintaining discipline and not allowing short-term market movements to derail long-term investment strategies.

Strategists believe that both tactical and strategic investors can benefit from a diversified portfolio that includes different asset classes with different levels of correlation.

For tactical investors, the note recommends taking advantage of market dislocations by making tactical shifts — reducing exposure to areas expected to underperform and increasing exposure to those best positioned for atmospheric volatility.

For long-term strategic investors, the main takeaway is the resilience of markets over time. The stock market has historically recovered from significant declines, often moving to new highs.

“For the long-term investor, time is on their side to potentially bounce back from these downturns if they remain disciplined,” the strategists continued.

“In our view, both tactical and strategic investors can benefit from using a diversified allocation that includes a selection of asset classes with varying degrees of correlation to each other.”

In addition, implementing a regular rebalancing strategy helps ensure that the portfolio remains aligned with the investor’s goals and maintains the desired asset allocation.