Assessing Volatility in Life and Investments

Volatility is often misunderstood and confused as risk, which it is not. How should investors manage volatility in their portfolios, and in life, to make better decisions?    

Simply put, volatility is the up and down price movements in company values. It’s common to think volatility only moves in one direction— down—but that’s not accurate. Volatility works both ways, up and down. As company prices are rising so is volatility. Reframing volatility as price movements is a good first step.     

Where volatility can be scary is when investors become surprised by it. Company prices do not move in a straight line and turbulence should be expected. Did you know that the average intra-year contraction among large US companies is -15% +/- a year? Every five years, on average, contractions may be -30% +/-. Over the past fifty years there have been three significant periods of volatility that contracted company prices by -50% +/-.  This occurred in the early 1970s with inflation and oil, early 2000s with the Dotcom bust, and then the Great Financial Crisis of 2007-2009.

There are no facts on the future, so investors need to be prepared and accept that owning companies comes with price volatility. In real life investing, it’s hard to stand still when companies are falling in value and fear-based mindsets take over. Investors can be better prepared by continuously reviewing cash reserves regardless of the direction of volatility.  

Once personal cash is spent, it’s important to follow a refill process. This can be challenging if no system exists. Too often, enthusiasm can get the best of investors, as owning companies is more exciting than periodically checking reserves. Assessing liquidity is boring, until it’s not. Surprise, volatility arrives and now there’s not enough cash as there should be.      

The necessity of cash may prompt a reaction by selling companies during volatile periods. This is avoidable with ongoing planning and liquidity checks. Once liquidated, cash tends to find its way into money market and/or fixed income investments. Volatility is present here too, just to a lesser degree when compared to owning companies. 

A sequence of difficult decisions is created when investors prematurely sell companies. First, they’ve interrupted the compounding that’s been taking place. Second, now in cash, when is the right time to get back in and repurchase companies? Third, when you do go back in, is it little by little, in chunks, or all at once? No one can successfully time an exit and reentry with any consistency. On top of that, taxes are generated when these transactions take place outside of retirement accounts.

So, why own companies at all? Why not just accumulate large amounts of cash in less volatile investments and call it a day?  Or why not seek out investment products that limit downside volatility?

The answers are simple, but not easy to implement consistently on your own. Life is expensive and your portfolio should prepare you for rising costs. The best investments are the ones investors might hold onto by not reacting to volatility.

Cash reserves play a role in financial planning, but not as an asset class for growth. Cash loses its purchasing power over time due to inflation. Certain investment products may offer protection from downside volatility. But, by definition, these same products must also limit upside growth. You can’t have your cake and eat it too. So, what’s an investor to do?

It begins by accepting volatility for what it is, not being surprised, and increasing your knowledge of how your investments fit together. With some patience and flexibility investors can accept volatility today knowing at some point this too shall pass.          

Life would be easier if volatility was isolated only to investments, but it’s not. Volatility is present in so many aspects of our daily lives. Our health, relationships, work, and schedule all include cycles of volatility. Investment volatility can seem easy when working through personal challenges or responding to what’s happening now.

Taking the same skills and lessons we learn from investment volatility and applying them to our daily routine can be valuable. Slowing down, being patient, stepping back and looking at the big picture before taking the next step. I recognize this is easier said than done, but it’s a strong possibility if you want it to be.

Financial planning can offer updates to your thinking as dollars are given purpose and aligned with your priorities. With this evolving approach, perspectives may become clearer. This may lead to more time to think and grow in the direction you want. Significant and positive changes in your life are possible by understanding volatility beyond your investments.       

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