Stock Market Volatility Explained in Four-Letter Words
Stock markets continued sailing in early 2018, and then at the end of January reversed course. In February, volatility spiked, and twice during the week of February 5th, the Dow Jones fell by more than 1,000 points.
Going through this volatility, two four-letter words kept coming to my mind: math and fear. No doubt these declines can be alarming especially when being bombarded with sensationalistic news stories. Headlines like “Market has largest loss on record!” were common and playing on fear.
“News programming uses a hierarchy of if it bleeds, it leads. Fear-based news programming has two aims. The first is to grab the viewer’s attention. In the news media, this is called the teaser. The second aim is to persuade the viewer that the solution for reducing the identified fear will be in the news story.” (Psychology Today, June 2011)
The U.S. stock market had recently reached new highs. Then it had large “point” losses. Who cares about points? I don’t nor should you.
The Dow fell by more than 1,000 points on two different days the week of February 5th. This amounted to about a 4% decline per day. On Black Monday in 1987, the Dow only fell by 508 points. Yet, the Dow lost more than 22% that day. You tell me what matters more – points or percent.
Throughout 2017, we gave our clients a quiz prior to meetings held in our office. Please take the quiz now yourself.
These questions were asked to more than 120 clients – many of which are not only smart but also well-read on investing. Probability would say that blind guessing would yield about 8 people getting both right. However, only five answered both correctly.
Why such dismal results? Investors generally believe the market is not as volatile as it is, and the market had been quite calm for some time. This is exactly why we posed the questions. We wanted to not only remind our clients but prepare them for what inevitably would happen. Our hope in doing so was to have prudent behavior and discipline when market volatility returned.
What Should Investors Do
Some may suggest trying to sit out this volatility. Having a tactical or market-timing approach sounds great. Who wouldn’t want to only participate in the market’s ups but miss the downs. Unfortunately, actual results of investment professionals show timing doesn’t work. Some may get lucky a time or two, but luck isn’t a sound principle to base your life savings upon.
Rather, several studies show asset allocation – the recipe utilized to combine the ingredients of your portfolio – explains more than 100 percent of the levels of returns you will receive over time. Why more than 100%? Because market timing and security selection (aka stock picking) subtract returns on average over time.
Focus on another four-letter word: plan. You should have a financial life plan that is custom tailored to align your financial resources to meet your unique goals. Your plan should be stress-tested to ensure you are not taking more investment risk than you can afford. Then your investments should be allocated in a way to best meet your goals while also ensuring taxes are minimized.
If you have a sound plan, continue to work it. If you don’t have a sound plan, perhaps February’s volatility is a reminder that you may be overdue for one. Planning will yield many benefits, including helping you to be able to tune out the unintelligent fear-mongering that is very light on relevant math.
(The correct answers were (1) once a year and (2) every four years. Source: Capital Research and Management Company for U.S. stock market from 1900-2016.)
Kevin Kroskey, CFP®, MBA is President of True Wealth Design, a wealth management firm with deep expertise in retirement, tax, and investment planning, providing complete integration of your financial life. Kevin can be reached by calling (330)777-0688 or by email at email@example.com and offers a complimentary initial consultation.