Volatility scares many investors. People don’t enjoy seeing their assets lose value, even in the short term. But volatility doesn’t have to be scary; it’s a matter of perspective.
The issue with volatility is timing. This issue arises in two fashions.
Volatility and Timing
Volatility is by nature short term. When we see an asset or a market decline over a period of days, or perhaps weeks, we attribute it to volatility. If the same thing happens over months, it’s a trend. Volatility is up and down movement in prices over a short period of time. If it is only up movement, it’s not volatility. And if it’s only up movement, it’s not scary either.
The other time issue with volatility is the time until when an investor needs to make use of their funds. This is the issue that generates fear.
It’s not the fear of the assets losing value temporarily that bothers most investors; it’s the idea that they may not have the funds to do what they want to do.
Most often this is in the context of retirement planning, as that is the universal goal. People save for many things, but nearly everyone who saves for retirement.
How to deal with volatile investments depends on the amount of time until the assets are needed for the goal. Let’s begin by talking about saving for retirement when retirement is still a long way out, say 10 or more years away.
Far Away From Retirement
If retirement is 10 or more years out, volatility may be uncomfortable, but it also may help more than it hurts. With market-based investments, such as stocks, the objective is to have as many shares of an investment as possible at the greatest price at the time you need the money.
Volatility, as a temporary drop in prices, is effectively a sale that investors can take advantage of. When prices are temporarily down, it is a buying opportunity, as your amount of dollars will purchase more shares while prices are lower. This ultimately helps you later, when you need to have as many shares as possible at the greatest price.
If you are already all invested, and your goal is a long way away, the temporary price drop doesn’t hurt you. It’s the price and number of shares you have at the time you sell that matters. Volatility is like bumps in the road. They make the ride uncomfortable, but they don’t need to derail the journey.
If you are close to retirement, or even in retirement, the scenario is different. Similar, but different.
Near or In Retirement
If you are close to retirement, or early in retirement, most of your assets should still be invested for the long term. For example, if you are 62 or 65 or so, you should probably have about two years of expenses in cash and another four or five years of expenses in nonvolatile assets.
Beyond that, your investments should still be working for you, which necessitates having some exposure to volatility.
As you spend from cash, you then refill the cash bucket from short-term assets and the short-term assets from long-term assets. This allows you to select when to redeem long-term assets. You don’t need to liquidate long-term assets during a period of volatility, as you have two years in cash and another four or five years in nonvolatile assets. You can weather the storm.
The problem for retired people isn’t the volatility; it’s the portfolio structure. If you have set up your portfolio so the long term feeds the mid term, which feeds the near term, you don’t have a volatility problem. You have a volatility problem only with an improperly structured portfolio, where you are spending from volatile assets.
Goals Other Than Retirement
The volatility issue for goals other than retirement is really no different. If the goal is near, there is no reason to be in volatile assets. If you are saving for a much needed down payment in two years, you should not be in a position to experience volatility. If you are saving for a vacation home in 15 years or for education needs in 10 or 15 years, then you can afford volatility, as you won’t be spending the funds at this point.
The Bottom Line
For most investors the problem isn’t volatility; the problem is fear. And the fear comes from not understanding either the market or the investment that they are in. This leads them to think that they are not going to achieve their long-term goals because of temporary price fluctuations.
Generally, these price fluctuations, aka volatility, won’t keep you from achieving your goals — unless you do something harmful, such as take the money out of the investments. The number-one way people hurt themselves is by selling at the wrong time, when their investments are down.
Markets are perspective driven. It’s not the news that drives markets; it’s what people think the news might mean long term that drives the markets. Once the news cycle changes, people think something different, and the volatility is behind us. Volatility is real; the cause of volatility is typically perception. If you are in the right investments for the right reasons, that doesn’t change because of other people’s perceptions of the market. If you are in the right investments for the right reasons, your best bet is to hold course. This shall pass.