Markets Are on a Roller Coaster Ride. Here's What to Keep in Mind as Stocks Whiplash

Morsa Images | E+ | Getty Images

The U.S. stock market has been on a rollercoaster ride of late.

Stocks slumped again on Tuesday after a wild trading session a day earlier that resulted in some of the largest recoveries on record.

The Dow Jones Industrial Average shed about 400 points Tuesday morning after rallying from a roughly 1,100 point loss to close higher during Monday's session. The S&P 500 fell about 1.7% after briefly dipping into correction territory, a drop of 10% or more, on Monday. The tech-heavy Nasdaq Composite traded more than 2% lower early in the day.

While this kind of whiplash can be troubling for investors, experts caution against making any rash decisions when markets fall. Volatility can lead to opportunities to buy more of their favorite stocks and set themselves up for future gains.

Volatility is the norm

All investors should accept market volatility — which is relatively common — as a normal part of the process of investing and the best way to outrun inflation, said certified financial planner Brad Lineberger, president of Carlsbad, California-based Seaside Wealth Management.

"Embrace the volatility, because it's why investors are getting paid to own stocks," he said.

This means investors should stay calm even through extreme movements. While stocks always move up and down, long-term market returns are still based on the same things: dividend yields, earnings growth and change in valuation, according to Zach Abrams, a CFP and manager of wealth management at Shaker Heights, Ohio-based Capital Advisors.

Movements up and down can also be a good time to review your asset allocation. If you're worried about a big drop, you could rotate part of your portfolio into some less-risky stocks to protect from a potential market correction, which is a drop of more than 10%.

Volatility means opportunity

When stocks fall, it can also be opportunities to buy more and set yourself up for future gains, according to Abrams.

This is because when stocks decline from recent highs, they're trading at a discount and will likely recoup losses at some point.

Continuing to put money in the market when it's down as opposed to selling is a great way to make sure you don't miss out on a reversal. Data shows that selling when the market falls can take you out of the game for some of the strongest rebounds.

More from Invest in You:
Companies raise perks to repay employees' student loans
The 'Zoom' ceiling: Experts worry remote work will hold women back
Work-from-anywhere jobs are hard to come by. These companies have them

For example, if you missed the best 20 days in the S&P 500 over the last 20 years, your average annual return would shrink to 0.1% from the 6% you'd have earned if you'd stayed the course.

Be prepared for emergencies

Of course, even if you know that stock market volatility can benefit you in the long run, financial advisors still recommend having a cash emergency fund on hand so that you can make it through a market meltdown without selling. This is especially important for retirees.

If the stock market falls, it's better to spend the money in your emergency fund than sell assets at a loss that can't be recouped, according to Tony Zabiegala, chief operations officer and senior wealth advisor at Strategic Wealth Partners, an Independence, Ohio-based firm.

This also keeps stock investments in the game for big turn arounds, which generally come shortly after market corrections or even smaller dips.

For example, an investor would have needed only three months to six months of living expenses in an emergency fund to avoid taking losses during the March 2020 meltdown, said Lineberger at Seaside Wealth Management.

This approach would have also kept investments in the market for the record-breaking rally stocks enjoyed after the pandemic slump.

SIGN UP: Money 101 is an 8-week learning course to financial freedom, delivered weekly to your inbox. For the Spanish version Dinero 101, click here.

CHECK OUT: My side hustles bring in $5,000 a month: Here's my best advice for getting started via Grow with Acorns+CNBC.

Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.

Copyright CNBC
Contact Us