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Volatility - Friend or Foe? Thumbnail

Volatility - Friend or Foe?

Recently, we have seen higher levels of volatility in the global equity markets.  This post will discuss volatility and what we should do about it.

Is volatility normal?:

Volatility is actually quite normal.  In an average year since 1980, stocks in the S&P 500 have an intra-year decline of 14%.   This means that inside of any year, even if the return for that year ends up being positive, at some point during the year the stocks in that market went down 14% on average.  I guess what I'm trying to say here is that what we experienced in 2018 thus far is not out of the norm.

What does volatility mean for us as investors?

It would be totally fair for you to ask: Mark, why would I subject myself to regular declines in my portfolio?  I thought the reason for investing was to make the money grow? 

Completely reasonable feelings and questions.  The answer is that, although stocks are more volatile than other investments, historically they have also provided us with a far greater long-term return than that of other investments.  Unfortunately, we can't have the out-sized returns without the volatility.  It just doesn't work that way.

So, if you have stocks in your portfolio in any significant volume, you are going to temporarily see the value of your investments go down. To try and avoid the volatility of stocks and still get the returns from stocks is not possible.  Sitting through volatility is the price you need to pay to get higher expected returns in the future.

The good news is, that for investors who can embrace volatility (the temporary decline of stocks) you can turn this into a huge advantage.  For those who are in the accumulation phase, the temporary pullbacks can become opportunities to purchase more shares at lower prices.  If you believe in the long-term trendline, that stocks will outperform other investments and that even though they temporarily retreat, you can look at these pullbacks almost as a January white sale and pick up shares at bargain basement prices.

What We Should Do About It

So if we believe that volatility is normal, and it is the large part of the reason why stocks give us higher returns in the long run - what can we do to make it easier for us to handle when it occurs?

The best thing to do is to have a plan and a portfolio that is tailored to you and your unique financial goals.  The plan will let you sit back and be ok with temporary declines because you know that they are completely normal and that they are a signal that you are invested in the type of things that are going to give you higher expected returns in the long run.

The worst thing we can do is try and time these corrections, and move in and out of our investments to try and gain an advantage.  The best thing I've read on corrections was spoken by the superstar mutual fund manager of the 1980s and '90s, Peter Lynch: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in the corrections themselves.” 

Chart source: Dimensional Fund Advisors Canada

The information in this material is not intended as investment, tax, or legal advice.  Please consult your advisor or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.