Why your account value rises and falls
Insights from Morgan Stanley Wealth Management06/16/21
Summary: The value of your portfolio can increase or decrease for any number of reasons. Economic trends, company events, and interest rate changes are among the common drivers of fluctuations in your investment account. While you can't prevent volatility, you can help manage it through diversification.
Your main goal when you invest is, of course, to earn money. Ideally, your account would see steady gains over the years, but investments don’t follow a straight line. Along the way, you can expect your portfolio value to move up and down, as many factors can affect the price of assets like stocks, bonds, exchange-traded funds (ETFs), and mutual funds. They range from smaller events, such as a company announcing an acquisition, to broad macro factors, like geopolitical events or monetary policy decisions from the Federal Reserve.
In contrast, assets like cash, money markets, and CDs tend to be less affected by those forces. With little-to-no price fluctuations, these types of investments are generally considered very low risk and, consequently, generally produce very low returns.
Understanding these influences will help you shape your portfolio to match your risk tolerance, time horizon, and investing goals.
It is important to note that over short time periods, such as days or weeks, there may be no clear explanation for asset price moves–what the experts sometimes refer to as “noise." However, here are some common reasons why your account may rise and fall over short or long time periods.
- Stock moves
Equities are a foundational asset class for many investment portfolios whose value can fluctuate due to many factors—from company-specific news to broader economic trends.
When the economy is thriving, stocks are more likely to rise and when the economy is struggling, stocks may see a downswing. Investors sometimes turn to indicators like jobs reports, retail sales reports, or changes in manufacturing and non-manufacturing survey data for clues about the broader economy.
Company-specific events that can drive changes in share prices include earnings reports, dividend announcements, executive changes, regulatory findings, or acquisition announcements.
- Major events
Significant non-financial events like natural disasters and pandemics, or geopolitical events like wars, or international conflicts can trigger market movements. Negative events often weigh on stocks and boost the value of “safe-haven" assets like US Treasury bonds and gold as investors feel more uncertain about the future. Positive events create a sense of security or optimism and have the opposite effect.
- Industry changes
Investments in specific companies can be affected by how well their sector is performing. When an industry is thriving, stocks in that sector will usually rise, and vice versa.
For example, if the retail industry sees more sales from increased consumer spending, retail stocks will typically benefit. Or, if the housing market is struggling with sluggish sales, home building stocks may suffer. Keep in mind: Not every company within a sector will react the same way to these trends, but they will impact the basket of securities in that sector.
- Interest rates
The Federal Reserve's (the Fed) monetary policy decisions have a direct effect on the prices of stocks and bonds, the latter of which often pay their investors according to a fixed schedule of cash flows. When policy decisions cause interest rates to increase, the present value of those promised cash flows decline to match the yield investors can get elsewhere, lowering the price of an investor’s bonds. On the flip side: When interest rates fall, bond prices rise.
Factor in potential interest rate changes if you plan to sell bonds before they mature or to reinvest their promised cash flows back into the bond market. However, if you have bonds and intend to spend their cash flows as they are realized, for example through use of a bond ladder in a retirement income strategy, interest rates may have less of an impact on your plans.
Monetary policy also affects the value of stocks. Stocks generally have a tailwind when the Fed is easing monetary policy, for example, cutting the policy interest rate, and may experience headwinds when the Fed is tightening monetary policy, for example, raising the policy interest rate or tapering asset purchases.
Understand your risk tolerance
The list above names some of common reasons for volatility, although there are many other potential reasons for changes in your investing account.
While you cannot prevent changes in the value of assets like stocks and bonds, you can take steps to align your portfolio with your financial situation. Being proactive with your asset allocation can tailor your portfolio's potential for ebbs and flows to your comfort level.
The first step is to understand what your capacity for risk and risk tolerance means for your portfolio strategy. Younger investors with a longer time horizon may have a higher risk capacity because their portfolios have more time to weather ups and downs, but may or may not have the tolerance for such a ride. They may want to invest more aggressively with a focus on equities to try to achieve more gains, but that depends on whether they can stomach the journey.
Older investors who want to protect their principal for a secure retirement often have a lower capacity for risk. They also often have a lower risk tolerance than younger investors, but that is not always the case. Indeed, some older investors with long experience of investing in the stock market are more comfortable with volatility than younger investors. The correct mix of more conservative, income-producing bonds and growth investments like equities for older investors should depend on the balance of these factors as well as their financial goals.
How diversification may help you manage volatility
No matter your risk tolerance, you should aim to build a portfolio with a “diversified” variety of investments to help you manage volatility. A diversified portfolio tends to provide the most consistent and stable investment results over the long-term.
When you diversify, you spread your portfolio among investments with varying exposures to risks. The intent is to make sure that all assets in the portfolio are not suffering deep losses simultaneously. Ultimately, this helps reduce the potential that the portfolio will suffer a deep loss.
You can diversify your portfolio by including investments that vary with respect to:
- Asset class (e.g., stocks, bonds, commodities)
- Industry (e.g., technology, retail)
- Geography (e.g., US, Europe, Asia)
- Equity style characteristics (e.g., smaller or larger equity market capitalization, lower or higher price to earnings)
- Bond maturities (e.g., short-term, intermediate)
- Bond credit quality (e.g., AAA, AA, BB)
The bottom line
Every portfolio experiences volatility—it's par for the course when it comes to investing. Diversifying across asset classes and other investment characteristics can help weather inevitable market moves.
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