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Can't Beat Volatility? Manage It Instead!

Friday, June 17, 2016

by Sheila Jamison and Rich Jamison

The financial markets ended 2015 and began 2016 on a roller coaster. All of the main US yardsticks, the Dow Jones Industrial Average, the S&P 500 Index and the NASDAQ Composite demonstrated this. As uncomfortable as it was, it has happened before (see Volatility From Everywhere and China Spooks Market) too.

Several recent years of exceptionally low volatility may have made us all a bit too comfortable. When things returned to ‘normal’, comparison with that new comfort level made ‘normal’ look much worse than it looked previously. (We are using “normal” to mean naturally occurring; not to imply that the markets run on any schedule.)

Still, you've probably said to yourself, "I don’t like the market swings. I get some attractive gains, and then I see my account dip and give them back. I wonder if I should sell something … or maybe sell everything and get out of the market entirely!"

If you have had these thoughts, you're not alone. Whenever volatility strikes the financial markets and short-term losses (albeit “paper” losses) come into play, it’s easy to think something is seriously wrong (see Guessing Causes Pain and Forced To Choose). However, nothing is “wrong” at all! Though we don’t like them, short-term losses are natural part of the cycle that is the stock market. “Right” and “wrong” are merely labels we assign that reflect our wishes. You can appreciate how those who are “short” the market could feel a market drop is “right” based on their desired outcome.

That said, the positive return for the equity market has not come in a nice straight line over the last 18 months. During the first half of 2015, the S&P 500 Index had four pullbacks of at least 3 percent and four rallies of a similar 3 percent or more. You may not readily remember these in light of how much more dramatically last year ended and this one began.

Similar pullbacks have occurred throughout the history of the market. Some, like those in 1929 and 2008, admittedly have been of far more dramatic magnitude than have others. However, the market recovered after even these, and then climbed higher than it had been before they occurred.

Does reacting to short-term events with short-term thinking accomplish anything productive? Most of the time, it is neither lucrative nor emotionally productive.

Steady, Consistent Growth

We’d all like our assets to go up ... and up … and up. We’d like our investment accounts, 401Ks, IRAs, etc. to be worth more tomorrow than today … every day. We’d also like life to be fair, just and equitable. However, life is not fair. Most people intuitively understand this fundamental truth of life. We also know that the stock market does not go straight up (check out the pictures in Volatility Tolerance and Tolerance Part 2).

Aren’t Bonds Different?

Fixed income markets demonstrate volatility. Put simply, bond prices also fluctuate. Interest rates changes magnify those price moves. Concern exists currently because bond prices change inversely to interest rates. Our low interest rates at present are likely to go up – with a concomitant fall in bond prices.

True, if you own an individual bond and hold it to maturity, you can get face value for that bond (as long as the issuer has the means to pay it). Even so, consider how much that “face value” may have lost in buying power because of price inflation while you held the bond. At current interest rates, the money you get back will likely buy less at the bond’s maturity than it did when you bought it. Moreover, if you have to sell that bond before maturity for some reason, you may have to sell at a substantial loss to face value as well.

Market Volatility (e.g., a Pullback) Is Normal

Most of us are only concerned with volatility when it is in the down direction. We generally hold upward market spikes to be fine. As noted earlier, little in life, including the stock market, can be counted on to move up in value consistently. The market has cycles like businesses, seasons and - dare I say it – real estate, have cycles. No one can reasonably expect sales, the temperature, house prices or the market to go up all the time. Moreover, some pullbacks allow us to find good values and opportunities to buy desired securities at better prices. That may even hint at opportunity to you.

Managing for Volatility

We can help you manage during volatility as well as during strong, solid market uptrends. We can analyze volatility for its severity. When it reaches certain levels, we can recommend stages of defensive maneuvers specifically for you. There are times to take profits, times to cull the weak members out of the herd, times to buy into other positions at bargain rates, and other moves that may be appropriate for you and your objectives.

It is important to keep your resources and your objectives clear in your own mind to manage volatility effectively. It is equally important to factor in any changes that occur to either your goals or your resources to achieve them. Want to buy a new car … or a boat … or a new house? Come into some additional cash from a bonus …or your 401(k) … or an inheritance? Each plays a role. (By the way, keep us advised on your situational changes and we’ll keep you advised regarding your changing options.)

That Is the Easy Part

Considering emotions, what you do in your portfolio to manage volatility spikes turns out to be the easy part. The hard part is changing the conversation that begins to play in your head. Behavioral finance has shown investors feel the pain of a loss twice as much as the joy of an equivalent gain. Focus on the potential loss during a volatile period (even if they’re only ‘paper’ losses) and you’ll operate from that perspective. Focus on how to manage that volatility instead and you’ll work on coming out better for the experience.

As Tony Robbins so often says, learn to ask yourself better questions. “How can I get the most out of this?” is so much more useful than “What is going to become of me?” Henry Ford is credited for saying “Whether you think you can, or you think you can't – you're right.” As with Robbins’ questions, whichever one you choose, your mind will go to work on it immediately. The right mindset helps you to ride out short-term paper losses with less emotional distress.

Pay attention to those clear objectives mentioned earlier. Avoid getting into situations where you could be motivated to panic-sell and it’s highly likely you won’t have to sell your stocks at the absolute worst time. Do you know what’s worse than “selling them wrong?” Seeing them rise in value shortly thereafter!

So, the next time you look at CNBC (or your monthly statement) and see red numbers instead of green, coach yourself. When things get scary, it’s easy to want to do most what we should be doing least.

Do Less Than You Feel You Should!

Recognize that short-term market dips are neither good nor bad. They are just dips; a natural part of the market. Being prepared to deal with them constructively often can pay off handsomely in the future.

Want an example of what not managing volatility can do? Talk to anyone who sold all of their securities in 2008 and then laid low for a year or two or three. Most likely, they still have not recovered fully. They could have more than recovered by now … if they had not acted out of emotion.

Bottom Line

It isn’t possible to know just when which assets will hold leadership positions within our asset class ranks, when those will change or what will come next. No one can. Unlike most media pundits, we don’t guess at when a market rally or pullback has exhausted itself. The market will tell us. The crucial element is to listen to what the market says.

We couple that knowledge with your specific resources and objectives. Our process then helps us determine what adjustments might be best for your portfolio. Discipline in the method helps us navigate the choppiest of market waters together.

Whenever you have any questions regarding strategies that might be useful to your particular situation, please let us know. We would be happy to discuss them in detail with you.

The data above were taken from sources deemed reliable. However no guarantee can be made as to their completeness and accuracy.
Interpretations of the data, views and/or opinions expressed are those of the Jamison Financial Group based on market and economic conditions as of the date of publication and are subject to change.
They do not necessarily reflect the opinions of any other individual, group or organization.
Nothing in the above is meant to be, nor should it be construed as, investment advice or recommendations to buy or sell any security. Individual securities whenever mentioned are for illustrative purposes only and may not be relied upon as investment advice.
All indices are unmanaged and are not illustrative of any particular investment. A direct investment cannot be made in any index.
The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.
The NASDAQ Composite is a market-weighted index of all the over-the-counter common stocks traded on the NASDAQ system. 

The S&P 500® is a market-capitalization-weighted index of common stocks.
Tax and/or legal information contained herein is general in nature and for informational purposes only.
It should not be relied upon as advice. Consult your tax professional or attorney regarding your unique situation.
Past performance is no guarantee of future results.
© 2014 Jamison Financial Group. Please feel free to distribute copies to individuals you feel may benefit from the information presented. Commercial use is prohibited.