Investors Should Examine Their Taste for Volatility (Opinion)

No doubt about it, the stock market has become more volatile.

In recent weeks we’ve seen days where the Dow Jones industrial average was down 300 followed by an up 300 day.

It’s enough to leave you wondering, “What was that all about?”

Volatility goes both ways, but for most investors volatility to the upside is not nearly the problem that volatility, to the downside is.

The VIX index, a measure of stock market volatility has spiked in recent months.

As an investor, how do you manage volatility? It’s easier said than done, but here are some thoughts.

• Remember that volatility comes with the territory when you are investing in stocks. The variability of returns is the ‘risk’ in the risk/reward tradeoff between stocks and other asset classes.

Over longer periods of time, stocks have historically produced higher returns to compensate for that risk.

If you are looking for those higher equity returns, you should invest with the knowledge that volatility will accompany them.

• Volatility produces opportunities. Anytime you see dramatic swings in the market you know that prices can become disconnected from the fundamentals.

A disciplined investor uses these opportunities to accumulate shares of solid companies at attractive prices.

Every day we research companies with good earnings and strong balance sheets that trade at valuations which we consider too high. If those fundamentals remain stable, then sell-offs can present an opportunity to buy at more reasonable valuations.

Downside volatility is also a benefit to dollar-cost-averaging investors such as 401(k) participants who are able to put money to work at better prices.

• Think back to your asset allocation decision. Remember that decision was made with the knowledge that stocks can be volatile, but there is a longer term goal in mind.

Over the long term, equities have returned 10.4 percent annualized versus 5.5 percent growth in government bonds.

The year-to-year ups and downs are a feature of stocks’ volatility, but for those with the discipline to withstand the variation, equities were clearly the better investment.

Given the strong growth in the stock market, hindsight makes it clear that each dip in stocks was in fact an attractive buying opportunity.

But each of those opportunities, at that moment, felt as uncertain as the market does today.

Successful investing requires a long-term perspective and the discipline to stand by your convictions.

That said, if stock market volatility is truly too much to handle, now might be a good idea to revisit your asset allocation. Can you achieve your retirement or other financial goals with a shift toward historically lower-returning but less volatile bonds? And do you really want to sell stocks in a down market? History says stocks have provided higher returns over the long term, but an allocation to fixed income can provide that ‘sleep-at-night’ factor as well.

(James Bell, CFA is a portfolio manager at Garrison Asset Management, an SEC registered investment advisory firm recently named one of the top wealth management firms in the country by Wealth Manager Magazine. He may be reached at (479) 587-1045.)