Stock Volatility — Is This Time Different?

Marilyn Capelli Dimitroff
Marilyn Capelli Dimitroff

Perhaps you’ve noticed that people who have been investors for a long time don’t make predictions about what the “market” will do in the coming year or next several years.  Most of us start out thinking that, by examining the right factors and by using the right analyses, we can know the direction specific investments will move.  But experience is a powerful teacher.  We soon learn that our ability to make shorter term projections is flawed.  And that’s OK.

Still, when investment prices are sinking, our brains automatically seek an “expert” who can tell us what’s going to happen.  The problem is, no one can do that.  In mid-January 2016, MarketWatch carried a report on its Forecaster of the Year award, noting individuals whose forecasting record beat the Bloomberg Consensus in 2015.  Only four people in the contest actually did better than the consensus. The very best forecaster beat the Consensus 55% of the time – making him right in a little more than half of the periods.  His success could be brilliance or just luck.  His 2016 forecast, by the way, is for modest growth but he’s “not totally dismissing” the stock sell off.

No one has a crystal ball.  But here are three things we know:

  • Market declines don’t last forever. Since last May, stock values have dropped world wide. This situation is not at all unusual.  This decline, like all others before it, is temporary and makes it possible for higher gains down the road. It is an impermanent disruption in the increasing value of companies worldwide over time.
  • Market declines occur regularly. Stock market returns have averaged about +10% annually since good record keeping began in the 1920s.  But this return has not been achieved with comfort.  It has come with days, months and years of hand wringing and outright fear.  Without these regular downturns, we would never achieve the long-term returns that stocks can provide – the reward for enduring the rocky ride.
  • Investment success is not about timing.  No one in the world – ever – has consistently made correct market calls over time.  That should be no surprise.  While we can all speculate on what will happen based on what we currently know, it is the events that unfold in the future that will determine returns.  Those events haven’t happened yet and are virtually unknowable.  Volatility doesn’t cause losses.  It’s our reaction to volatility that creates problems. The ability to tolerate downside volatility is essential to capturing the attractive long term returns stocks can deliver.

So what can we do?

  • PA_Blog_Feature-Images_2016_WEBINAR_Volitility_020916Stay the course.  We know that making investment decisions on emotions doesn’t work and destroys value in the long run.  We all hate seeing values decline.  Instead, good decisions need to be based on your current and evolving financial plan.
  • Create and update a financial plan. Financial planning is critical to having clarity about where we are now and where we want to go.  It enables us to design an investment strategy that is aligned with our needs and goals – one that is based on good sense and not on luck.  Stocks are inappropriate to meet short term needs but they are extremely useful, even essential, for our lifetime goals.
  • Maintain a diversified portfolio.  While we may lean a bit from time to time in particular directions, it’s important to hold a mixture of assets that don’t react the same way when exposed to the same risk. No one knows which asset class will be the winner at each year’s year end.  But we do know that a steadier portfolio, one which holds some assets that zig while other areas zag, is likely to have a higher compound return over time, providing better long-term financial outcomes.

While the factors that cause market declines may vary widely (a tech bubble, mortgage crisis, recession, etc.) from downturn to downturn and usually feel unique, the outcomes are remarkably consistent.  Ultimately, the problems causing the decline are resolved as adjustments are made and the market corrects, leading to the next round of rising values.  Is this time different?  It isn’t.