How does volatility affect your portfolio?

According to a search, volatility is “liability to change rapidly and unpredictably, especially for the worse.” In this millennium, we’ve had 2 to 3 stock market crashes, nearly 20 years of war and armed conflict, increasing polarization, a transition from an industrial age to a digital age, an ongoing climate change battle, and of course a pandemic that is redefining modern society. While the stock market has delivered impressive returns ever since 2008, the ride has been anything but smooth. And we believe volatility of all types will remain a central theme in the future.

While there are many ways to address the question above, let’s focus on the most significant effects.

VOLATILITY – THE MATH

Many investors would be satisfied with a 6.5% return on an investment. But how do you know if you actually realized 6.5%? If you held an investment for the last 10 years, and the average rate of return over the last 10 years was 6.5%, does that mean you earned 6.5%?

NO.

Why not?

Because of volatility . If you were to invest $100,000 for 2 years, and it were truly to grow at 6.5% (like an unimaginable CD), you would have $113,422 in two years. ($100,000 x 1.0652).

But is that how the market has been behaving over the last many ye­­ars? Has the market slowly but surely climbed at a predictable and modest rate over time, or has it spasmodically lurched up and down with every crisis and Federal Reserve intervention?

In February, the market “corrected” by about 30%. While it hasn’t quite reached its former highs, let’s consider where the market would be if it increased 43% from February.

It would be back to where it started before February!

Let’s consider that $100,000 investment again but this time the investment loses 30% the 1st year and then rebounds 43% the 2nd year:

Year 1: $100,000 x 30% loss = $70,000

Year 2: $70,000 x 43% gain = $100,000

In this case, despite a staggering 43% gain in Year 2, the investment is break-even at $100,000.

But isn’t the average rate of the return for the investment still 6.5%? Yes! (43-30)/2 = 6.5%

The point is that, when it comes to YOUR portfolio, the average rate of return doesn’t matter. What matters is YOUR PERSONAL rate of return, and it is mathematically provable that volatility is harmful to index-based investment performance. Yet, chances are, you’ve never heard that reasoning, or had the math shown to you by a financial professional. 

VOLATILITY – THE EMOTION

There is another significant effect of volatility. It is the impairment of critical thinking, to include euphoria and panic. How hard is it, during an exhilarating run-up, to be able to sell high and cherish the gains? Doesn’t the fear of missing out cloud our judgment? And when the market has hemorrhaged 40% in the wake of a dotcom crash or financial crisis like in 2008, doesn’t panic-selling take effect, causing people to lock in horrific losses from which they may never recover?

There is a third major consequence of volatility. It is the stress, apprehension, and dread we feel when we ride that roller coaster, and the toll it takes not only on our finances but on our health, our relationships, and our overall happiness. Stress actually kills.

Ask yourself whether you expect more or less volatility going forward. If you think we’re in for more instability and rapid change, here’s an even better question:

What if you could make volatility work for you rather than against you?

There is a way to protect yourself against the unpredictability of an irrational stock market, and to capitalize on it as well. Contact us at arieffconsulting.com and we will show you how.

You don't have to lose money in order to make money. Free yourself from this negative assumption and break from the herd!

Links

Best Stock Fund of the Decade (requires WSJ subscription). he best-performing mutual fund over a 10-year periogrew more than 18% annually. "Too bad investors weren't around to enjoy much of those gains. Would you believe the average investor LOST 11% annually over the same period?

Threats to your portfolio

Volatility Harms Your Portfolio – October 2020 (Pdf Download)

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Disclaimer: This newsletter represents the opinion of Arieff Consulting, Inc, and does not constitute financial, tax, or legal advice.