UNEASY UNSETTLED UNCERTAIN
Financial Markets Experienced A Bumpy Ride During The First Three Months Of 2016. Although The S&P 500 Index Of Large, Domestic Stocks Was Positive For The Quarter—Returning 1.35%—The Journey Was Hardly Smooth.
Indeed, stocks began 2016 by registering their worst 10-day start to a calendar year ever, and proceeded to fall 10% through mid-February. Over that time, stock prices experienced significant volatility—severe short-term ups and downs in value. For example, the S&P 500 posted more 1%-plus swings during the first two months of 2016 than 94% of all the 2-month periods since 1991.
Then, after bottoming out in February, stocks began an uneven path upward that took prices 11.6% higher by the end of March from those February lows.
Faced with frequent and wild gyrations in the value of their assets during the quarter, many investors felt increasingly UNEASY,UNSETTLED and UNCERTAIN about their financial security and their progress toward their most important life goals.
At Horizon, we understand those reactions. There are times when the markets seem to be doing their best to make investors nervous and cause them to question their approach to investing. At such times, it’s vital to have a strategy in place that allows investors to navigate the challenges and stay committed to their plans.
The key to doing that is through UNDERSTANDING. The fact is, it is easy to misinterpret the type of volatility that we saw during the quarter. By viewing volatility through the correct lens, one that puts market ups and downs in the proper context, investors will be able to make decisions that are in their best interests at all times—including when big market swings and short-term losses dominate the headlines.
Understanding Volatility: Friend, Foe Or Both?
To gain a true understanding of volatile markets such as the current one, it’s important to recognize just what volatility is—and what it is not.
When most investors hear the word “volatility,” they assume it’s something negative. That’s because the popular financial press typically mentions volatility only when stock prices are falling fast. Based on that, it’s easy to assume that volatility is nothing more than a Wall Street way of saying “big losses.”
But here is the truth: Volatility does not have to mean negative returns—nor is it necessarily a bad thing. Quite the opposite, in fact. For long-term investors seeking to grow their assets to achieve key financial goals, volatility is a vital ally.
How, exactly, is volatility an investor’s friend?
First, it’s important to understand that volatility is not the same thing as risk, which involves the potential for permanent loss. For example, when stock investors buy shares of a particular company, they incur the risk that the particular firm could go bankrupt and that the value of their investment will become worthless. They risk losing their money for good.
In contrast, volatility reflects the price movements of a stock, a sector of the stock market or the entire stock market—to the downside (when stock prices fall) and to the upside (when stock prices rise). Therefore, volatility represents both the ups and the downs that investors experience. When stocks fall 1% in a day, that’s volatility—but when stocks soar 1% in a day, that’s also volatility.
It’s the upside volatility—the big increases in stock prices that frequently occur over short periods—that is a key driver of the superior returns that stocks have delivered over time. Other asset classes (such as bonds and cash) have generated significantly lower returns over the long run than stocks. Part of the reason is because those other asset classes tend to experience far less upside volatility.
This is great news for stock investors. It means that the amount of volatility inherent in the equity market is actually helping fuel stocks’ superior returns over time—the exact returns that investorsneed to grow their assets sufficiently to reach their key life goals.
Of course, volatility can also work against investors. An extended patch of significant downside volatility, when stock prices are falling fast, can erode investors’ assets right when they need them most—and put their future financial security into question.
What’s more, downside volatility can cause some investors to panic and make investment decisions that go against their best long-term financial interests and needs. By making moves like fleeing from stocks and locking in losses instead of holding tight and waiting for markets to recover, investors can quickly put themselves in a financial hole that is difficult to climb out of.