Despite intermittent, short-lived rallies, by October 3, 2011, the S&P 500 had declined 19.4% from its high reached on April 29, 2011, just missing the threshold that traditionally signals a new bear market.¹

However, within days of the sharp decline, U.S. stocks had recovered nearly
all their earlier losses, surging 17%.¹

What do the market’s steep declines and equally stunning advances imply for 2012 and beyond? Some would argue that heightened volatility is now part of “the new normal,” whether you rely on the recent past — or historical evidence — to make your case.

A Historical Perspective

Historically, the market today is about three times more volatile than it has been in the past. Specifically, the S&P 500 rose or fell by 2%+ an average of seven times per year from 1950 until 1999. Since 2000, however, that average has jumped to 26.7 times per year.²

Pinpointing the cause of recent market woes is a difficult — if not impossible — task.

Uncertainty about when and how fully the U.S. and global economies will recover is a major factor. So are the heightened reliance on the Federal Reserve’s monetary policy, government debt troubles both at home and abroad and the U.S. credit-rating downgrade. Perhaps most important is the apparent inability of legislators in Washington to soothe market fears and improve the economy.

Coping With Volatility

Regardless of the causes, heightened volatility requires individuals (under the guidance of their advisors) to employ specific investment strategies. While these are fundamental investing concepts that can be applied at any time, they are particularly important in a volatile environment.

Don’t panic. When markets become volatile, the gut reaction for most of us is to panic. Many investors do exactly what they should not do: Buy when everyone else is buying — when prices are highest; and panic sell on the downside — when prices are depressed. Panic selling also exposes you to the risk of missing the market’s best-performing days.

For example, missing just the five top-performing days of the 20 years ended December 31, 2010, would have cost you more than $19,000 based on an original investment of $10,000 in the S&P 500.³

Take advantage of asset allocation. During volatile times, more risky asset classes such as stocks tend to fluctuate more, while lower-risk assets such as bonds or cash tend to be more stable. By allocating your investments among these different asset classes, you can help smooth out the short-term ups and downs.

Diversify your stock allocation. Within stocks, it is important to diversify by sector, size, style and location. Why? Because different types of stocks, like different asset classes, often take turns outperforming one another.

Keep your long-term priorities in focus. Regardless of how well you diversify, you are still likely to see some fluctuation in your portfolio when markets turn volatile. But making major changes in response to market performance over relatively short time periods may not be prudent. Instead, review your portfolio and rebalance (if necessary) on a regular schedule, such as once or twice a year.

¹Source: Standard & Poor’s Equity Research Services, “Baby Bears and Near Misses,” October 31, 2011. The S&P 500 is an unmanaged index that is generally considered to be representative of the U.S. stock market. Individuals cannot invest directly in any index. Past performance is not a guarantee of future results.

²Source: Standard & Poor’s. Based on the daily close of the S&P 500 from January 2, 1950, through October 5, 2011.

³Source: Standard & Poor’s. For the period indicated. Stocks are represented by the S&P 500, an unmanaged index that is generally considered representative of the U.S. stock market.