Cole Foster, CFP
Expected market volatility, measured by the VIX Index, spiked in the month of January… In plain terms, the market expects prices of companies in the S&P 500 to become increasingly volatile in the days ahead. The graph below plots the VIX index since the start of 2022 through 1/25/22 - In that period, expected volatility has increased 88%.
With this turbulence comes concern from investors - here are five things to keep in mind when markets become volatile:
The talking heads on TV and writers in financial publications are incentivized to sensationalize their claims…
The wind coming from the mouths of "experts" can cause waves in the portfolios of investors - after all, talking heads don't get airtime by being boring. If you want your name to circulate, you need to make a bold call… If your bold call is negative, then your name will circulate all the faster. Additionally, we can’t trust that every chart, stat, or headline we see and hear is honest or accurate… There is a quote that comes to mind – If you torture the data long enough, you can make it say whatever you want. Take a healthy dose of skepticism whenever you hear claims that the sky is falling.
Matching the risk in your portfolio with your unique tolerance for risk is paramount…
One of the most important services a financial planner can provide clients is ensuring the risk in the client’s portfolio is commensurate with their need, ability, and desire to take risk. Our firm utilizes a technology called Riskalyze to help us determine where a client falls on the risk tolerance spectrum. This is a vital component of our portfolio construction.
Volatility means different things for different investors…
Do you have an annuity with riders in place to protect your income? Volatility likely scares you a bit less than the average investor.
Are you a younger investor who is still in the accumulation phase? Volatility is an opportunity for you and something that you should welcome!
Volatility isn’t scary or even a negative variable for all investors… make sure you are properly assessing your situation before falling victim to the incessant fearmongering that is so pervasive in financial media outlets.
It happens…
Volatility and the fear of loss have always been around and will always be around… We are often asked if we foresee a major market loss in the future… The answer is always Of course! We just have no idea when. If anyone tells you they have the answer, please stop listening to that person immediately. The future is unknown, which is why we place such importance on having a financial plan in place, protecting the portfolio income for those investors who are dependent upon income from their portfolio to live life, and having an appropriate level of risk in the portfolio that matches that investor’s risk profile. If we didn’t have risk in financial markets, there would never be the opportunity for a reward… there are no free lunches; investors must embrace risk if they expect a return – how much risk is the question.
Booms and busts are likely to happen faster than ever before…
Retail trading, including easy to use apps, such as Robinhood, are wildly popular. The boredom of the pandemic led to a new generation of investors dabbling in the stock market for the first time. This phenomenon, paired with the ever-increasing popularity of quantitative trading utilized by some institutional investors, such as hedge funds, has culminated in quicker and more exaggerated market movements. Technology has allowed for fear, greed, and fads (such as trading meme stocks) to travel quicker, wider, and more efficiently than ever… This means retail traders, who move in and out of positions quickly (sometimes in the same day), are moving markets like never before. Similarly, quant trading, which relies on mathematical models and algorithms predicated on quantitative analysis, has also contributed to the speed at which markets climb and fall. The point? Don’t allow for the emotions of a dramatically bad day to determine an investment decision, because there is likely an exceptionally good day in the near future.
The Takeaways
Professional talkers are paid to talk… the more outlandish things they say, the more attention they get. Don’t fall for their games.
Make sure you have properly measured the risk within your portfolio and ensure it is commensurate with your need, ability, and willingness to take risk.
Volatility isn’t bad for everyone… if you are a net saver, then relish the opportunity to invest at lower prices.
It will happen… It will happen.
It will likely happen faster than ever, so stay patient, stick to the plan, and be willing to weather the storm.
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