Broker Check

How to Make Stock Market Volatility Work for You

By Howard Hook, CFP®, CPA
Published in the New York Daily News "Daily Views" column
January 22, 2016


Ask yourself the following question regarding stock market volatility: "Is it good or bad for my portfolio?"

Your head may say it’s good, but your heart probably tells you something else.

In fact, stock market volatility is good for the long-term investor.

Volatility as it relates to investments can be viewed as the range of returns of an investment during a given period of time. The narrower the range of returns, the less volatile the investment is.

Volatility can be positive and negative, although the same investor who has no concerns about volatility when the markets are going up can also be tremendously concerned about the same volatility when markets go down.

One of the key tenets of investing is the relationship of risk to return. The riskier the investment, the greater the return the investor should expect from that investment.

Using volatility as a proxy for risk would suggest that the greater the volatility of an investment the greater return should be expected.

The investment with the lowest volatility is cash. Therefore, you would expect that the returns for cash would be the lowest as well. Among the big three asset classes (cash, bonds and stocks), the volatility of stocks is highest. Therefore, the expected returns for stocks should be the greatest, and over long periods of time this is the case.

Another key takeaway regarding volatility is that the longer you stay invested, the narrower the range of returns.

The range of stock market returns over one-year periods is quite large, as some years the market declined quite a bit (-37% in 2008), and other years the market grew significantly (+35% in 1995).

However, when measuring stock market returns over longer periods — such as 10-year periods of time — the range of returns narrows (-1% to 19%).

Clearly the longer the holding period, the less volatile the stock market is.

So how then should you deal with the current stock market volatility and make it your friend?

You can start by re-reading this column to remind yourself that higher volatility suggests expected higher future returns.

The corollary to higher returns is that if you invest in assets that are less volatile your returns are likely to be lower. This may hamper your ability to outpace inflation, which for those who are retired, or planning to retire soon, is the greatest enemy your portfolio may be facing.

Next, make sure that any cash needs you may have over the next three to five years will come from assets such as cash (or bonds) and not your stock investments.

Knowing that any cash needs you may have do not have to come from selling investments in your stock portfolio can give you reassurance that any market declines will not affect your ability to meet your cash needs over the ensuing three to five years.

Finally, reminding yourself that you are a long-term investor, and that as long as you stay invested the current market volatility will not harm you, will help you deal as well.

While your heart may still not love the increased volatility, you probably will be less likely to unfriend it.

This article was originally published on www.nydailynews.com