How to Tame Market Volatility
In my last article, I explained how annual stock market returns often vary widely from their long-term average. That’s volatility for you. If your investing time frame is 12 months from today, there’s no telling where you’ll land. You may touch down exactly where you aimed your investment “parachute,” but you’re far more likely to end up in a tree or a lake.
Still, you can control your near-term investing needs: Don’t invest that money in stocks. If you need your money back a year from now, buy a CD or a similar conservative investment. The money won’t grow much, but it will still be there for you when you need it.
If you won’t need your money back for years, the opposite is true. Say you’re saving for retirement, 20 or 30 years out. Here, you have a better chance of landing where you’d like by investing in stocks for the long run. Sitting in safe holdings won’t get you very far.
Think about annual stock market returns over the next five years. Each year’s returns can be all over the place. But over five years, they’ll start to average out, making the range of possible returns over five years much narrower than it is over any one year.
If you’re planning for retirement, you’re planning for your life expectancy, which I hope is many decades. Across decades of market highs and lows, you can expect the overall average to tighten to a point you can actually plan toward with far more confidence than a few years allows for.
In addition to time, here’s another volatility-taming trick: Reduce the impact of near-term market volatility by investing across various types of investments. Simply put, statistics show that not all types of investments tend to rise and fall together. How do you dampen your portfolio’s overall volatility, compared to the volatility of any one type of holding? By owning multiple types of holdings that tend to rise and fall at different times, under different market conditions.
Correlation is the fancy word for these rising and falling relationships. While that’s fun to know, how correlation works deserve its own article. We’ll save that for another day.
Written by John A. Frisch, CPA/PFS, CFP®, AIF®, PPC®