Volatile Investment Markets and Your Future Wealth
Volatility is a measure of risk. It is a statistic that reveals how investment returns are dispersed over time for a market or security. Most investors enjoy volatility as part of a strong uptrend in market prices. However, those same investors may fear down-side volatility, and with good cause. Market volatility has the potential to erode your net worth and your future wealth.
Volatility is inevitable. So, what can you do to weather the ups and downs? There are steps you can take now to insulate your retirement investments from future market volatility.
The Nature of Volatility
Volatility expresses how far data points vary from what might be considered average. For example, a fixed-interest savings account has little or no volatility. That’s because you earn a constant return (the interest rate) from one day to the next. The account exhibits no dispersion of returns – all returns are equal to the average, or mean, return. For example, if you own a three-year CD paying 3 percent, then the annual returns for years 1, 2 and 3 are each 3 percent, which is also the average return. There is no variation.
In this case, the volatility of the returns is zero, as measured by the data’s variance, which is the spread between individual returns and the average return. Statisticians express volatility as the standard deviation, which is the square root of variance. It too is zero for a fixed-interest savings account.
The stock market is quite different from a savings account. Every day, the prices of individual stocks and indexes for the broad market rise and fall, creating a dispersed pattern of daily, monthly and annual returns. The more a stock “yo-yos” around its average return, the higher the standard deviation – hence volatility.
What Volatility Means for You
Market volatility can stir the emotions. It’s hard not to react when markets make sudden, large moves. Greed and fear are natural human emotions that, if given free reign, can lead investors to buy high and sell low. That can be a recipe for wealth destruction. To handle your retirement fund’s volatility without panic, you must be able to stand back from the daily noise of the markets and adopt a long-term perspective.
Planning is the antidote to panic. The time to develop a strategy for managing market fluctuations is before they happen. Planning starts with an understanding of how you and your portfolio will react to volatility, and then making moves to restructure your wealth to fit your risk profile. If you react to the inevitable downside volatility that markets exhibit by selling all your stock, you won’t be in a position to profit when the selling period ends and an up-market resumes. This can devastate your retirement funds, because you will handicap your ability to recover from a bear market. That’s why planning is so important.
Asset Allocation is Key
Diversifying your investments across a broad set of asset types should be a central feature of your retirement planning. Knowing your tolerance to risk, stage of life and need for liquidity should shape your asset allocation so you can tolerate volatility without it triggering sudden, unplanned reactions.
We've noted in our 48 years of helping families that clients often ask: "Why take any risks at all with your retirement account as you approach or enter retirement?" The reason is inflation. Today’s 65-year-old might be looking to live well into their 80s or 90s. Unless a portion of your retirement funds are invested in higher growth (and therefore volatile) assets, you will be unlikely to keep up with inflation. That would be unfortunate, because you could lose buying power, and your remaining nest egg could be worth less.
How an Advisor Can Help Keep Your Eye on the Prize
A financial advisor can help you invest for retirement by applying the best data to support rational actions, not emotional reactions. An advisor can help you assess your risk tolerance and guide you to invest in ways that preserve your future wealth while protecting against inflation. That’s why excellent communication between you and your advisor helps you achieve the results you want.
When you work with a skilled fiduciary advisor, you can benefit from sophisticated tools that assess your risk tolerance and show how your portfolio will react to various market scenarios. Remember, your risk tolerance, how you feel about risk, is a key element in your financial planning. The results factor into how you will allocate your money to different asset classes. Together, you and a financial advisor can restructure your portfolio to match your risk profile. A properly structured portfolio can help you resist the knee-jerk impulse to do something, anything, when markets jump.
A fee-only fiduciary financial advisor can be a good financial coach who can help you learn to tame your emotions in the face of volatile markets. Nothing can destroy your future wealth faster than overreacting to current events by constantly jumping in and out of your investments. An advisor can show you how to adopt a long-term perspective, reducing the impact of emotions that can distort your investment performance.
An experienced team of advisors can offer clients peace of mind, and help them replace concern with confidence.
Linscomb & Williams has been helping families build, preserve and manage their future wealth for more than 40 years. A fee-only, fiduciary financial planning and investment management firm headquartered in Houston, Texas and serving investors nationwide, we have nearly half a century of experience developing custom and comprehensive financial plans that work for each individual client that seeks to preserve their wealth through all market environments.