Money & Finance

Understanding Market Fluctuation & What Investors Should Do

In case you missed it, the S&P 500 has inked yet another record for the books. Between February 19, 2020, and March 23, 2020, the S&P 500 took a tremendous drop, losing 33.9%. However, this drop was immediately followed by the biggest 50-day rally in the S&P 500’s history. From the low point on March 23, 2020, to June 3, 2020 (50 trading days later) it rose an impressive 39.6%

In case that meteoric rise didn’t grab your attention, think about it this way; In less than two months, the S&P 500 experienced a rally of almost 40%. A rise of that magnitude, over a 50-day span, hasn’t been seen since it’s inception… 63 years ago.  

Although heavily influenced by the economic implications associated with COVID-19, the period between February 19, 2020, and June 3, 2020, is just one example of market fluctuation.

So, what is market fluctuation?

Simply put, market fluctuation is a reflection of all the ups and downs in the price of individual stocks within a specific market index. For example, the S&P 500 is an index made up of 500 US large-cap stocks (companies valued ≥ $10 billion) traded on the American Stock Exchange. This particular index includes big companies like Microsoft, Alphabet, Facebook, Visa, and Johnson & Johnson.

Market fluctuation in the S&P 500 occurs as a result of the continuously changing stock prices of those 500 companies. The collective stock price fluctuations of those large companies are what cause the entire S&P 500 market to fluctuate.

What causes market fluctuation?

Changing stock prices are the primary driver for market fluctuation. Stock prices themselves change for a variety of reasons including economic health, the financial health of individual companies, and current events.

Economic health

In many instances, market fluctuation is influenced by the overall economic health of the country. However, it’s important to remember the two don’t always go hand in hand. Typically, economic data is backward-looking. For example, unemployment, gross domestic product, and international trade data are all analyzed by looking at the previous quarter or month. The stock market, on the other hand, is forward-looking.  Investors buy and trade stocks in advance of what they expect to occur.

Financial Health of Companies

Another factor that impacts stock price is the financial health and perceived value of individual companies. It goes without saying that we invest in stocks under the belief that stocks and companies will increase in value. Whether increased value contributes to a stock’s increase in price or is paid out in dividends, we expect a return on our investment. When enough of us believe a company is undervalued and financially healthy, it drives demand and therefore increases stock price. 

The opposite is also true. When companies show signs of decreased financial health or lower profits, demand tends to decrease and may ultimately result in a lower stock price.

Current Events

Despite what might seem like an unbiased, numbers-based world, the stock market can be highly emotional. Stock market trends are easily influenced by events in the news, whether good or bad. All sorts of news topics including political events, social unrest, government policies, industry changes, and consumer spending trends have an impact on stock market fluctuation and the individual prices of certain stocks. 

Remember when the world was panicking about how certain computer programs wouldn’t be able to recognize dates post-1999? It was speculated that technology-dependent governments would collapse and the economy might have a full-blown meltdown. The US alone spent an estimated $300 billion dollars on upgrades, crisis management, and preparedness for the new era. The Y2K pandemonium caused major market fluctuations, particularly on technology firms. Luckily, those fears did not come to pass, and many tech sector stock prices soared in the year 2000.

For example, Intel experienced its highest stock price of all time on August 31, 2000, at $74.88 despite a great deal of market fluctuation as a result of Y2K.

example of market fluctuation: intel stock price 1999-2000
Data source: Macrotrends

Market fluctuation is intimidating 

Market fluctuation can be incredibly intimidating to investors. While humorous now, Y2K scared the heck out of a lot of people, and rightfully so. While there was no governmental or economic collapse as many people feared, Y2K had a very real impact on the stock market. 

What should investors do about market fluctuation? 

So what can investors do in the face of market fluctuation? There will always be fluctuation and volatility in the market. But it doesn’t mean there aren’t best practices investors can abide by in order to keep their portfolios as healthy as possible.

Stick to these four best practices

1. Don’t panic

The stock market is volatile. And it will continue to be volatile. But it has always rebounded and continued an upward trend in the long run. Trust in the fact that it is almost always in your best interest to stay the course.

2. Don’t try to time the market

Timing the market doesn’t work. If you panic and pull your money out of the market prematurely during a downtrend, or wait to invest until stock prices hit their lowest price, you’re more likely to miss out on gains than you are to get the timing right. 

3. Diversify appropriately

If you’re still feeling panicked and are tempted to try timing the market, you’re likely better off altering your diversification. A well-diversified portfolio is one of the best ways to reduce the overall risk of your investments. Diversifying amongst geographic markets, industries, stocks, and bonds will leave your investments much less susceptible to acute market fluctuation.

4. Reduce your costs

Reducing the costs associated with your investments will leave more money in your portfolio to grow. One of the biggest investment costs are fees associated with actively managed funds. While actively managed funds tout better performance and low fees, these costs can add up quickly.

Even a 1% annual fee can add up to hundreds of thousands of dollars over the lifespan of your investment. Moreover, actively managed funds aren’t likely to beat the performance of index funds over the long run. In the 15-year time span between 2004-2019, 91.6% of large-cap active fund managers still underperformed compared to their passive counterpart – the S&P 500. 

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