How to Put Stock Market Volatility into Perspective
Despite all the excitement in January and February, 2018 has been a relatively subdued year so far with respect to stock market volatility and performance. Our stock market's high and low for the calendar year to date were set just a couple of weeks apart on January 26 and on February 9 respectively. The S&P 500 has basically been chopping around within that range ever since despite a variety of financial crosscurrents.
Domestically, investor enthusiasm over strong second-quarter economic growth and corporate profitability has been tempered by concerns about a flattening yield curve, a growing budget deficit, and a less accommodative Federal Reserve. Stock market investors here also seem increasingly unaffected by more global concerns such as the deterioration in various trade "negotiations", the political climate in Europe, and the recent softening in the economic performance of our major trading partners.
Are we whistling past the graveyard? Regardless of opinion, these relatively quiet days in the markets seem opportune for preparing for the inevitable next bout of market turbulence, no matter its cause or timing. So how do you maintain your investing composure when all around seem to be losing theirs?
1. Lengthen your investment time horizon.
It's easy to get caught up in the daily swings of the stock market with TV channels dedicated to 24-hour coverage of financial news. And it's somewhat natural to extrapolate from short-term market performance, to begin to feel, for example, that a 5% weekly decline, if replicated for another 19 weeks, would wipe out your stock investments.
Not only does the math not bear this out, but the reality is that market volatility tends to decline the longer the time period you consider. Put another way, annual variability of stock market returns is less than monthly variability is less than weekly is less than daily. The inverse relationship between investment time horizon and variability of returns also holds for multi-year periods and other asset classes.
(To read a further discussion on the importance of time horizon and historical perspective in portfolio management, please click on The Importance of Investment Time Horizon in Asset Allocation Decisions.)
2. Broaden your perspective beyond the performance of your portfolio to the achievement of your financial goals.
While stock market performance garners much of the attention in the financial news, it is but one of many factors contributing to your eventual ability to fund your future financial goals. And that's the real name of the game, isn't it?
Stocks are volatile and dramatic and controversial, so they make great fodder for TV and eye-catching headlines. But your net worth - including holdings in diversifying asset classes like cash, bonds, commodities, real estate, home equity, business interests, etc. and net of liabilities like your mortgage, car loans and student debt - is a much better yardstick of how you are progressing towards your goals. When stock markets are making you seasick, take comfort in the fact that your net worth is much more stable.
Wealth management clients at Five Seasons have the benefit of being able to use an account aggregation tool to help track net worth through time. Other account aggregation services, an Excel spreadsheet, or even a pencil and paper, can serve the same function for the rest of you.
Even beyond your net worth, other factors like your health and longevity, inflation, taxes, your spending and savings patterns, your decisions regarding employee benefits and Social Security, and your future earnings power (your so-called "human capital") will also all weigh in to your success in attaining your future financial goals.
Stock markets will do what they will do. Returns generated by them are beyond our control, and our efforts to avoid market losses or accentuate gains through market timing are almost always counterproductive. So it stands to reason to focus your attention and your emotional resources on the factors above that you can control.
About the Author
Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.