Unless you’ve been living under a rock the past few weeks, you’ve probably heard that volatility has returned to the financial markets. This should come as no surprise after we saw positive returns every month in 2017.
But based on the way the news media talks about this volatility, we’d expect to see streets littered with corporate carnage and gutters overflowing with bankruptcies. This could not be further from the truth. In fact, the economy is doing quite well and corporations are benefitting.
It’s true that the recent volatility was among the highest we’ve ever seen in terms of total point moves. In fact, during a one-week period, the cumulative intra-day point change in the Dow Jones Industrial Average was an amazing 22,000 points. Cumulatively, that is an 85% change in one week.
The volatility that would normally be expected once or twice a year is now being happening one or twice a week.
Making matters worse, rumors are swirling that the “volatility index” or VIX has been rigged in a manner that allows people with very sophisticated computers to manipulate indexes. This, in turn, is causing tremendous volatility in individual stocks.
It remains to be seen whether or not this manipulation is actually happening. However, greed is a powerful emotion. Anytime greed rears its ugly head, flawed humans will try to take advantage—even if it means using clearly illegal tactics. Unfortunately, fear may cause investors to make irrational decisions that undermine their logical long-term plans.
Whether it is a matter of assessing massive volatility or manipulation, it is enough to frustrate the average investor.
Understanding all these concerns, here are some suggestions to help in achieving your goals:
Remember that someone else will always have a faster computer or trading system that will be several steps ahead of you. The average individual cannot outgun institutional computers. In fact, you shouldn’t even try. No one said you had to be a short-term trader.
The average individual needs to identify specific time frames for their financial resources. Short-term emergency funds need to remain liquid at all times. Funds needed in 3 to 5 years can be allocated to fixed income assets. Only funds that can be left invested for a long time frame should be considered for the stock market. This understanding should make short-term blips in the market far less worrisome.
Long-term in our world is a minimum of 5 years—but preferably 10 or more years. We have no idea what will happen with a stock’s price over any short time frame. However, over a 10-year market cycle, a stock’s price will generally follow its sales and earnings.
Time is the friend of the great company and the enemy of the mediocre one. Buying high quality companies allows you to be patient.
When you invest in stocks, you take ownership in a business. Stop worrying about ticker symbols. I highly doubt any sane person really thinks that within one week, the logical value of HEB, Buc-ee’s or Academy legitimately fluctuated by 85%.
Volatility is nothing new. Since World War II, the stock market has had intra-year drops of an average of 14%. The recent decline resulted in a 10% drop. This magnitude decline has happened in 50 of the last 72 years.
Volatility is not risk. Risk is the permanent impairment of capital—losing your purchasing power. Volatility generally comes from trading because people can’t sit still.
The recent volatility was made worse by investors using financial products that use borrowed money or unique financial contracts to double or triple the movement of a given stock, commodity or index. These products, often structured as ETF’s, ETN’s or ETP’s, are extremely hard to understand or accurately evaluate. However, brokerage firms and investment banks love these products because the fees are quite high. Anytime you can’t understand what you are investing in, don’t do it.
Focus on the things within your control. You are in control of what you own and how you allocate your hard-earned assets. Be a long-term investor, not a day trader or gambler. Today’s gambler is tomorrow’s bankruptcy.