After what could be described as a steady "melt-up" for the stock market in 2017, volatility has reared its head in the early going of 2018. For the first time in history last month, the nearly 122-year-old Dow Jones Industrial Average (DJINDICES: ^DJI) ended lower by more than 1,000 points during a single trading session not once, but twice -- minus 1,175 points on Feb. 5, and minus 1,033 points on Feb. 8.
Furthermore, the Dow logged some of its wildest intraday point swings since inception. Throughout its history, the Dow has moved over 1,000 points intraday on seven occasions. Four of its five broadest intraday swings occurred over a span of just one week in February, including a drop of nearly 1,600 points at its peak on Feb. 5, 2018.
What you should do when the stock market is volatile
For some investors, such as short-term traders, this volatility is highly unnerving and a potential cause for fear. But for long-term investors, this recent volatility is the perfect opportunity to sit back and reflect. Here are seven things long-term investors should do during a volatile market.
The first thing you'll want to do is breathe and not do anything rash, like sell all of your stocks. It's unlikely your entire investment thesis is going to unravel because the stock market has been volatile, no matter how many points the Dow or broad-based S&P 500 (SNPINDEX: ^GSPC) lose during a single session.
2. Realize this is normal
Next, take a step back and realize that stock market corrections -- defined as a decline of 10% or more from a recent high -- are perfectly normal. The S&P 500 has undergone 36 corrections since 1950, working out to about one every two years.
However, sticking with that bigger-picture view, the S&P 500 has also spent about three times as many days (more than 18,000) rallying or in bull market mode relative to the approximately 6,600 it's spent in correction or bear market territory since 1950. Regardless of how swift or volatile the declines have been, bull market rallies have eventually erased all 35 previous corrections (not counting the current one).
3. Put the volatility into context
Third, you need to put the volatility and declines you've been witnessing into context. In other words, stop focusing so much on nominal point swings, despite the awe that a 1,175-point decline might bring, and focus on the percentages that underlie them. In reality, not a single decline in the Dow has topped 4.6% during this correction, which is nowhere near the 20 worst single-day percentage performances of all time for the iconic index. In fact, we'd have to go back almost a decade to find the last time the Dow had a truly bad day (Dec. 1, 2008).
4. Reassess your investment theses
Investors should also take the time to reassess that their investment theses still hold water. Admittedly, anytime is a good time to review your holdings and ensure that the reason(s) you bought still make sense. Of course, when the stock market is going up in an orderly fashion, this isn't often a priority. With the market considerably more volatile than it was in 2017, now is the perfect time to ensure that your investment theses still hold true. If they don't for a stock or stocks, then it could be time to consider selling.
5. Add dividend stocks to your portfolio
Though nothing is surefire with the stock market, dividend stocks have historically run circles around non-dividend-paying stocks, because dividend stocks often have a time-tested business model. After all, a company wouldn't pay a dividend if its board of directors didn't have a positive outlook for the company. Dividends can also help hedge against inevitable stock market corrections, and they can be reinvested in even more dividend-paying stock, which can accelerate wealth creation.
6. Consider taking new positions or adding to existing holdings
While we're on the subject, consider taking new positions or adding to existing positions anytime the stock market dips considerably. As noted, the stock market has erased all previous 35 corrections, often within a matter of weeks or months. Though you won't make money with every stock you invest in, the simple fact that high-quality businesses increase in value over time should allow you to do pretty well if you maintain a long-term view and ride the winners for a long time.
7. Ween yourself off of margin
Lastly, if you happen to be using leverage (i.e., margin) to invest beyond simply short-selling equities, consider this volatility as a wake-up call to cut that out! While employing margin can result in bigger-than-expected gains, it can also be a path to steeper losses when corrections do inevitably strike. It's a gamble not worth taking.
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