Understanding Volatility

Build your portfolio with a higher tolerance for volatility

Many investors, especially those still reeling from the 2008 – 2011 stock market roller coaster ride, have developed a low tolerance for volatility. As a result they have moved a significant portion of their investments into bonds or other fixed yield vehicles. What many investors may not realize is that wholesale switches from one asset class to another in order to avoid volatility actually increases it. Secondly, for investors with a long-term perspective on their investments, volatility is actually a good thing, as it is the primary driver behind the sustained market gains over the last century.

Unquestionably the stock market has experienced some fairly severe volatility in recent years. But a more thorough review of the historical record provides a clearer perspective on market volatility over the decades that actually favor investors who manage to hang on even in the worst of market declines. The record has shown that market declines are nothing more than a momentary interruption in an enduring market advance. Hence, volatility is simply a necessary phenomenon of a market that works. On the other hand, market risk – the risk of incurring losses as stock prices fall – is human-induced. The only way investors actually lose money is when they sell their stocks.

Those who are suddenly spooked into bailing out of the market after it has already fallen 10 or 15 percent, will always lose money. Yet, history shows that the stock market rewards investors who can bear the volatility of stocks and avoid the harmful behavioral traps through various periods of performance. So, the real risk to investors isn’t being in the next 20 percent market decline, its being out of the next 100 percent market increase.

At Winship Wealth Partners, we use decades of academic research to coach our clients on the importance of embracing volatility rather than running from it as the way to achieve superior long-term performance.