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The Dilemma of Market Volatility

Depending on our ages and our respective time horizons, we each experience a different feeling during market declines when downside volatility picks up. I compare it to when I’m in an airplane and the flight hits moderate to major turbulence. I think through all the statistics that are working heavily in my favor for this flight to make its destination. However, I still wonder in my gut whether this plane can withstand all the violent back and forth and up and down movements. Are the pilots as nervous as I am? Are they reassuring the passengers just because that is what they are trained to do? Who is the pilot and how many flight hours on this type of aircraft does he actually have?

 

Market volatility often feels the same way to investors. Logic tells us to stay the course, but we get the most uneasy feeling in our gut when we do so. However, there is one main difference. Only the pilots can control the fate of the plane. Investors can and often do pull the plug on their investments to escape this dreaded feeling. Often times, this occurs during the tail end of a volatile period when it is most disadvantageous to the investor.

 

This article is not meant to be that gentle pat on the back to all investors telling them in the most calming of words to “stay the course.” Without a strategy, I think this would be foolish advice. My advice to investors is to have a strategy, determine that it meets your time horizon and risk preferences and then stay as consistent as possible with it. It is not market volatility, but rather a willingness to regularly change strategies, that can be the biggest enemy to an investor.

A VOICE OF EXPERIENCE

For younger investors, the task is not that difficult. They should have a well-allocated and diversified portfolio, maintain a good cash reserve (probably most important), and simply realize that sharp market declines present opportunities because of the decades ahead during which you will be investing. However, as we get older, the scenario becomes more complex. We no longer have the decades or even years of further contributions to make. Retirees will not be making contributions at all, but rather withdrawals. In these instances, it is most important to mentally break your portfolio down into buckets based on how aggressive or conservative the investments are. This is not an easy thing to do, but it will help make sense of your strategy and keep you sane during periods of significant volatility. But wait. When markets decline a lot, aren’t all holdings in the portfolio in decline?

 

The average person’s portfolio tends be broken down into a mix of aggressive and conservative assets. On the most conservative end, some assets may be in short-term FDIC insured CDs or money markets. These assets tend to weather significant market declines quite well. For pre-retirees, retirees, and any others that may need monies from the portfolio over the next 4-6 years, take a look at your portfolio and ask yourself whether these monies you need are accounted for in highly conservative assets. Do you always maintain an additional buffer of very conservative short-term assets should your needs be in excess of what was originally anticipated? If you don’t, at least a subtle shift in strategy may be needed. However, if you do, I would recommend evaluating the remaining allocation separately, making sure it is well diversified and well allocated according to your risk preferences, and recognizing that you have more than 4-6 years to ride out the ups and downs with these assets.

 

These periods when most assets decline (and decline sharply) are always scary like a really turbulent plane ride that never seems to end. However, if you are comfortable with the layout of your strategy and you have adequate conservative buffers to deal with any needs in the next several years, consistency may be your greatest ally and fewer changes may benefit you more than making a bunch of radical changes. Despite what seems like a whole host of folks making indications to the contrary, nobody knows what will happen to markets and when, making timing a futile effort. A good long-term strategy consistently applied seeks to put the statistics most heavily in your favor.

A WIDE RANGE OF SERVICES

*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss.

 

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

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