Volatility measures change

Stock market volatility tells us how often (and by how much) stock returns differ from their average values. However, it doesn’t tell us the direction of the difference (positive or negative). During a period of steady stock market declines, a period of negative returns doesn’t cause much volatility. But during a period of climbing market returns, a period of negative returns causes a lot of volatility.

I wrote about market volatility last summer amid concerns about a market slowdown. Turns out 2019 was a productive year for the stock market. In fact, the S&P 500 Index gained more than 28% in 2019.*

Following suit, 2020 kicked off with promise. The S&P 500 closed at an all-time high on February 19, 2020. But this better-than-expected market performance set us up for a bigger fall. On March 11, 2020, less than a month later, the S&P closed about 20% lower.

Panic & perspective

The coronavirus is expanding its reach close to home. Fear about our health, coupled with fear about the economic impact of the virus, can cause anxiety. Unchecked anxiety can cause panic. Stephen King said it more poetically than I ever could: “Panic is highly contagious, especially in situations when nothing is known and everything is in flux.” There’s no antidote to anxiety when our sense of well-being is jeopardized. But there are ways to prevent our anxiety from progressing into panic. I suggest investors do 2 things to keep calm (and I follow my own advice): First, don’t consider the what-ifs—there are too many possibilities without probability. Second, focus only on the facts.

Here’s what I know:

  • My family and I are taking all recommended precautions to stay healthy. If our circumstances change, we’ll deal with it like we’ve dealt with difficult situations before.
  • Market volatility is normal and expected. History tells us this too shall pass. Consider this: To date, every significant market fall has been followed by a rebound. We anticipate downturns; we just can’t predict how low the market will go or when it will bounce back.
  • I trust my asset allocation because it’s based on my time horizon, risk tolerance, and goals.

How others cope with uncertainty

I don’t know if market volatility will be the “new normal,” but I know it’s normal—so normal, in fact, we’ve posted several blog posts about it before. Here are some readers’ comments about how they cope with market volatility:

Dennis M.: Have a realistic plan and stick to it.

Thomas P.: I played out this scenario by accident and ignorance during the recession of 2007–2009. In 2008, the Dow Jones had dropped 50%, and my portfolio value dipped 41%. I watched the value decrease every month but was too scared to do anything. I guessed someday the market would come back, but if it didn’t, it didn’t matter much. I was able to quell the urges to sell, but it was about the hardest thing I’ve ever done.

Dan C.: Time in the market. Not timing the market. Works for me. Keep it simple.

David R.: No, I don’t “do nothing.” When equities are down, bonds are often up and vice versa. Volatility brings investment opportunities to rebalance, moving funds between equities and bonds.

Vincent G.: I look at volatility as part of it—if you’re actively investing, you’re buying more shares.

Keith M.: During my working years while contributing to a 401(k), I came to terms with volatility and actually looked at down markets as good for my retirement account. I wasn’t planning to start tapping the account for many years, so in real terms I had lost nothing yet. Better still, every 401(k) contribution purchased investments at bargain prices, so when the markets eventually recovered, I was better off than if the markets had maintained a steady climb! Now that I’m retired, I don’t contribute to the 401(k), but I reinvest my dividends, so I take the same view—dividend payouts stay the same in down markets, but buy more at depressed prices.

Jay W.: I always find it interesting that volatility is equated to risk. Volatility juices returns over the long run, so I want volatility!

Harischandra P.: The word risk is often used. This is an ill-understood word, even among the professionals. Volatility isn’t risk. Risk isn’t having enough money when you need it. Volatility is your friend at the top, to sell if you need money, again at the bottom, to buy if you have money to invest.

We’re listening (well, reading)

Some people feel better when they talk with others. If that’s you, take advantage of our virtual investing community by posting a comment below.

*Source: FactSet.    

Notes:

Past performance is no guarantee of future returns.

Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.