Does Your Portfolio Embrace Market Volatility?
Many investors, especially those still reeling from the 2008 – 2011 stock market roller coaster ride, have developed a low tolerance for volatility. As a result they have moved a significant portion of their investments into bonds or other fixed yield vehicles. What many investors may not realize is that wholesale switches from one asset class to another in order to avoid volatility can actually increase it. Secondly, for investors with a long-term perspective on their investments, volatility may actually be a good thing, as it has been a driver behind the sustained market gains over the last century.
Unquestionably the stock market has experienced some fairly severe volatility in recent years. But a more thorough review of the historical record provides a clearer perspective on market volatility over the decades that may actually favor investors who manage to hang on even in the worst of market declines.
Winning with Market Volatility
Since World War II, the stock market has experienced, on average, an intra-year decline of 14 percent each and every year; and in that same period, the market ended lower, on average, by 18 percent every third year. Bear markets, with an average decline of nearly 30 percent, have occurred every fifth year. Yet, over that same span of nearly seven decades, stock market values have grown despite the periodic market declines.
The very profound and highly instructive take away from this is that market declines have, thus far, been nothing more than a momentary interruption in an enduring market advance. Hence, volatility is simply a necessary phenomenon of a market that works. On the other hand, market risk – the risk of incurring losses as stock prices fall – is human-induced.
Those who are suddenly spooked into bailing out of the market after it has already fallen 10 or 15 percent, may lose money. Yet, history shows that the stock market generally rewards investors who can bear the volatility of stocks and avoid the harmful behavioral traps through various periods of performance.
Building Your Portfolio around Market Volatility
Proper diversification is the key to withstanding increased volatility and reducing downside exposure. A well-diversified, strategically allocated portfolio may decline in value less than the stock market indexes. If your portfolio only declines 7 percent while the stock market declines 12 percent, you’ll have less to recover.
Focus on your Long Term Objectives
During periods of increased market volatility it does little good to worry about the market-shifting macro events of the day that may have little or no impact on the long-term performance of your portfolio. The stock market decline of 2008 may turn out to be nothing but a small blip for a portfolio invested for 20 years. It took years for some of the investors who fled the market in 2008 to recoup their losses, while those who kept their sights on their objectives and stayed the course may have enjoyed gains in their portfolio.
Patience and Discipline
Volatile markets can cause investors to make costly mistakes, such as trying to time the market (which is very difficult at best), or chasing performance, or trying to pick the winners. These mistakes can cost investors a significant portion of their portfolio value. It takes patience and discipline to adhere to a strategy and avoid the herds. Stocks should generally be bought and sold according to a strategy, not in response to emotions.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2014-2015 Advisor Websites. Stock prices fluctuate rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Past performance doesn't guarantee future results.