Volatility is a normal and unavoidable state of the stock market. In the long run it helps us get even better returns because when the market corrects, meaning goes down, it gives money managers opportunities to reposition portfolios potentially into stocks or bonds that fell in price unjustly. In the long run it benefits our portfolio by enabling us to get better returns.

When government policies, tariffs and taxes are undergoing rapid change as is happening today it creates even more volatility and uncertainty. It’s something we are going to need to get used to and accept, at least in the near term. 

Markets like stability and they grow when companies can make plans that are predictable and know what to expect. 

Unfortunately, that is not the case right now. 

What are the Causes of Stock Market Volatility?

Economic Data and Indicators  Inflation, unemployment  GDP and interest rates are all factors that can impact stock market volatility positively or negatively.

Interest  Rates Federal Reserve interest rate cuts or increases impact market volatility. The cost of borrowing increases when interest rates rise which can be a drag on consumer spending and business investments often resulting in lower corporate earnings and stock prices. Interest rates coming down can have the opposite effect.

Corporate Earnings Reports  Corporate earnings reports are usually released quarterly and create stock price volatility if earnings are better or worse than expected. For most companies, earning season typically starts two weeks after the end of the quarter (in the middle of January, April, July, and October) and lasts approximately six weeks.

Political Events and Government Policy Changes  Elections and the initiation of new government policies such as tariffs can have far reaching effects that dramatically change the foundations of the economy creating volatility in ways that are not predictable. Changes in government regulation or tax breaks for example in the renewable energy sector can create volatility as the market sector adjusts.

International Events  Wars, terrorist attacks, pandemics like COVID-19 can trigger worldwide market volatility and disruptions to supply chains.

Industry Sector Events  The oil producing sector can be impacted by a wide range of geo-political events that has a ripple effect across all oil-distribution and petrochemical industries.

Market Sentiment  Investor psychology can be a short term driver of volatility pushing stocks to unsustainable levels. It can be very difficult to know you are in a stock market bubble until it bursts. That can lead to panic selling and crashes. The same is also true of market bottoms where fearful buyers are standing back waiting until a clear market direction is established. 

“Fear Index” of Market Sentiment

Emotion-based judgements that amplify market sentiment and volatility both up and down are measured by the “Fear Index” or VIX. It is measured by looking at the volatility of the next 30-day S&P 500 future options contracts.

The VIX can be a useful gauge of market direction with higher numbers indicating higher volatility and greater fear among investors. Stocks generally go down in that environment. Lower numbers indicate higher investor confidence and stocks usually go up. 

The VIX Fear Index can be a help tool to determine how much stocks may be over or undervalued due to emotion-based judgements during market volatility to help you stay focused on your long-term goals and overlook short term static.

Volatility Should be Expected to Continue

The current volatility level may continue for the foreseeable future.  All and all the markets may continue to grow, although we should expect it to be much choppier.

While you may lose money in the short term, look at how much money you have made in your portfolio in the last year or several years and keep in mind, volatility comes with the market. Corrections and even “Crashes” are part of the process!

Revisit Your Portfolio

The point is to understand and anticipate this reality and stick with a solid plan.  When we are experiencing volatility it’s a good time to meet your your financial advisor to revisit your portfolio and review your plan. 

Reexamine your portfolio and make sure it matches your current needs and your risk tolerance. It may be a time to move money to more conservative investments such as bonds or an annuity. If you still feel good about your investments just leave it as is and let time take care of the rest,

.

Have Faith in the Process

Over time there have been few greater creators of wealth than time in the stock market. However, the volatility can be emotionally charged, very disturbing and frightening at times!

Unless you are a day trader it probably best serves you and most investors not to be constantly checking your portfolio during times of great market volatility. Have faith in the process. 

Know that over the long term investors have always done well. So long as they have stuck with their plan – and so long as it’s a good solid plan! 

Volatility Creates Opportunity

Down markets create opportunities because it allows you to buy the dip for bigger profits when the market comes back. This is one reason to keep some cash on hand instead of being fully invested in stocks.

In a down market you can always take advantage of it by doing some tax planning. There are short term losses due to the downturn that you can take advantage of to save money on taxes at the end of the year. 

You may sell positions that have gains, but the gains may be smaller now. Or you can compare the losses you take with the gains and see if they offset each other. This enables you to rebalance your portfolio in ways that you may have previously been putting off due to the tax consequences.

There is a silver lining to down markets. We would all be happiest if the market just went straight up. But that’s not reality. That’s not how things work, because it’s the volatility that creates opportunity.

Your Solid Financial Plan is the Key to Lasting Success

The best thing to do to prepare for market volatility is start off building a proper portfolio that matches your needs and your risk tolerance. It may include a combination of stocks, bonds, cash and possibly an annuity or other insurance product as well as different categories of stocks, both domestic and  international.  Once your proper portfolio is built, then just let the process play out.

By nature, we should have safe money in funds that you’ll need for the short and medium term that is not invested in the market or affected by market ups and downs. This will help get you through any or all negative markets we experience. Then when the market turns around, by nature your portfolio goes back up.

It is not realistic to think you can time the market, meaning you will know with precision when to get out of the market, and know when to get back in. That has been tested to be almost impossible to do by people who dedicate 100% of their time trying to do exactly that! Realistically, how much time do you have to spend on it? 

If you ever do get it right it will be a lucky one time shot that you’ll probably lose it all back the next time! 

Conclusion

Stock market volatility is a dual-edged sword in that it creates risks, but it is also what creates profits. Volatility is not always a bad thing for long-term investors because it can provide better entry points buying the dip and rebalancing your portfolios for greater profits.

By understanding how volatility works and the factors that contribute to it helps us navigate the market with greater success and avoid expensive emotion-based mistakes by staying calm and keeping focused on the bigger long term picture.

Would You Like to Know More?

Steven Fenyves, CFP®, CFS, founded Valued Wealth Management in 2005. He and his team of professionals help successful professionals prepare for retirement on their terms and stay comfortably retired. They also design corporate retirement plans to serve businesses and their employees.

Steven graduated from Hofstra University with a BA in Accounting. He holds the Certified Financial Planner™ (CFP®) designation and he is also a Certified Fund Specialist (CFS).

Steven is a member of the Greater Boca Raton, Florida Estate Planning Council.

For more information or to schedule an appointment at our Boca Raton, Florida office please contact:

steven@valuedwealth.com
(561) 392-4646