Can I Use Market Volatility To My Advantage To Build Wealth?

The recent downturn in the stock market threw investors for a loop. Stocks plunged more than 10 percent in just a few days — a sharp drop that put everyone on edge. When the stock market plunges, it’s easy to panic and sell. But sharp investors use this kind of market volatility to play the long game, turning a market crash into a long-term opportunity to build their wealth.

“Just as retailers offer items at lower-than-usual prices on a temporary basis, the market does the same with assets such as stocks and bonds,” says Greg McBride, CFA, Bankrate chief financial analyst. “Whether at the store or in the market, a sale is an opportunity to scoop up bargains.”

Here’s how savvy investors think about stock market volatility and turn it to their advantage.

Profiting from stock market declines

Many investors see a stock market decline as something to be avoided rather than as an opportunity. That’s easy to understand — who likes losing money? But glance at a long-term chart of the S&P 500 index to see how a market decline is really an opportunity in disguise.

The price of the index moves up and to the right over time. Sure, there are plenty of dips along the way, but the direction is clear, even to a child. The index contains hundreds of America’s top companies, and it keeps rising, making it a popular choice among great financial advisors.

You can easily circle the places where it was the best time to buy. It’s those dips such as 2000-2001, 2008-2009 and even in early 2020, when the COVID pandemic first struck. Those times were exactly when investors were scared witless, sold everything and ran for the hills.

“Markets can be volatile in the short-term but a sudden downdraft creates opportunity for long-term investors,” says McBride. “Markets can fall more than warranted by the underlying fundamentals in a broader panic and may reverse course shortly thereafter, so making additional investments during that downdraft can pay off handsomely.”

It’s exactly at these “risky” moments that savvy investors such as the legendary investor Warren Buffett turn into opportunity, putting money to work at much more attractive stock prices.

“One of Warren Buffett’s famous mantras is to ‘be greedy when others are fearful,’ which perfectly sums up how to take advantage of a sudden market downswing in order to acquire assets at depressed prices,” says McBride.

And as an individual investor you have the ability to do exactly the same thing — setting yourself up to earn attractive returns when the market rebounds, as it eventually has.

How “buying the dip” supercharges your returns

So how does buying the dip in stocks work? It actually supercharges your returns. Let’s use an S&P 500 index fund to show how it might work. These funds own the stocks in the index, and over time their return looks close to the returns of the actual index, about 10 percent annually.

So the second column below shows the average S&P 500 gain of 10 percent over a period of five years, turning a $100 investment into about $161. In the third column is a hypothetical scenario showing high growth in the first two years, a year of low growth, then a decline of 10 percent. What return in year five takes the index back to its long-run average of 10 percent?

If you run the numbers, the return is 25.9 percent. That’s the return that’s needed to get the index back to its long-term average of 10 percent annually over the five-year period. That figure is vastly higher than the stock market’s long-term average, making it an ideal time to buy. So after a downturn, stock returns typically need to accelerate to achieve the market’s long-term average.

That’s why sharp investors are buying significant declines in the stock market and not selling them. You can supercharge your return — at lower risk — by buying after the market has fallen. You can even do well if you just continue to buy through the market decline as part of dollar-cost averaging, adding money to your investments regularly, including as part of your regular 401(k) investment. However, if you sell, you may miss that huge rebound if you need to buy back in.

How to invest when the stock market falls

When the market declines, you need a plan to act — and that’s a great place for a financial advisor. While it’s easy to look at a market dip after the fact and say you should have bought, it’s tough in the moment to take action against your emotions amid a plummeting market. That’s why it’s so vital to have your investment plan ready ahead of time, so you’re not paralyzed.

1. Don’t invest it all at one time. First, it’s important to understand that traditional declines, such as a bear market, usually occur over periods of months, so you don’t need to rush to invest all at once. In fact, when the market is falling, you’ll likely have a chance to buy at better prices as events play out. No need to rush.
2. Develop an investment plan. You need a plan for when it’s time to act. The plan may be as simple as continuing to invest regularly in your 401(k) or IRA, regardless of what happens in the stock market. However, you may decide to put money to work when the market has declined by a fixed percentage. For example, maybe you’ll put one-third of your cash to work when the market declines by 10 percent, another third after a 15 percent pullback and the final third when it hits 20 percent down. Whatever your plan, figure out something that can work for you and then stick with it.
3. Stick to your plan. You developed an investment plan when you were calm and rational, and in a market decline you’re not likely to feel either of those things, but it’s still vital to stick to your plan. The news will get awful and your investments will be down in the short term, but it’s important to focus on the long term and understand that the economy and market will improve over time, taking your investments along with them.

Dealing with the stock market’s volatility is one of the hardest things to do, but working with one of the best financial advisors is a great way to stay on track. Top advisors have lived through the market’s ups and downs, and they can help you stay on the long-term path to wealth, even when it starts to get rocky in the short term.

Bottom line

When the stock market dips, that’s when savvy investors start to emerge and make investments that they can hold for years and supercharge their returns. For individuals, that’s the way to play a long-term investing game they can win, letting short-term market volatility work in their favor.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.