“The markets – whether investors like to believe so or not – have always been unpredictable.”
– Ronald W. Rogé | Founder of R.W. Rogé & Company, Inc.
Stock market volatility is frequently a topic of significant concern, and it’s completely understandable for investors to feel uneasy when the market exhibits fluctuations. As a fee-only financial planning and investment management firm with nearly 40 years of experience, we have witnessed numerous cycles of market volatility. This isn’t the first downturn we’ve observed, and it certainly won’t be the last. With that perspective, let’s delve deeper into what market volatility really means, the nature of market corrections, how market shifts can impact your overall financial picture, and what you can do to ride out the storm.
Stock and Market Volatility: What Is It?
Stock market volatility refers to the frequency and magnitude of changes in the prices of stocks. It’s how rapidly and significantly stock prices go up or down over a short period. Volatility is a normal part of investing, and it’s important for investors to understand that these fluctuations are inherent to the nature of financial markets.
How To Calculate Market Volatility
Calculating stock market volatility can be approached in various ways, but a common method is using the standard deviation of returns. This approach measures how much the returns of a stock or an index deviate from their average over a specific period. Here’s a simplified step-by-step explanation:
- Choose a Time Frame: Decide whether you want to look at daily, weekly, or monthly price changes.
- Calculate Percentage Changes: Find out how much the price changes each day (or week, or month) compared to the previous day.
- Find the Average Change: Calculate the average of these daily percentage changes.
- Measure Variations from the Average: Determine how much each day’s change differs from the average change.
- Compute Volatility: The average of these differences tells you the volatility. A larger number means the price swings more wildly, and a smaller number means it’s more stable.
For investors, this figure can help provide a statistical measure of stock market turbulence, offering insight into the typical magnitude of price fluctuations.
Why Does the Stock Market Experience Volatility?
Several factors can cause market fluctuation, including:
- Economic Indicators: Reports on employment rates, inflation, economic growth, and other significant economic indicators can influence investors’ confidence and lead to volatility.
- Corporate Earnings: When companies report their profits, if the results are better or worse than expected, it can cause significant price swings in their stocks, affecting the overall market.
- Geopolitical Events: Events such as political instability, elections, international conflicts, or significant policy changes can create uncertainty and lead to volatility.
- Market Sentiment: Sometimes, the general feeling or mood of the investors—whether optimistic or pessimistic—can itself drive volatility as investors react to news, rumors, or market trends.
What Should a Novice Investor Know About Stock Market Volatility?
Navigating the ups and downs of the stock market can be daunting – especially for a novice investor. Understanding the fundamentals is key to building a resilient investment strategy that can thrive in both calm and turbulent times. Outlined below are a few central points to consider:
- Short-term vs. Long-term: Volatility is more concerning in the short term. Over long periods, the market tends to increase in value, despite short-term ups and downs.
- Risk and Opportunity: While volatility can indicate risk, it also presents opportunities. For example, when stock prices drop, it might be a good time to buy high-quality stocks at a lower price.
- Diversification: One way to manage the risk associated with volatility is through diversification—spreading your investments across various asset classes (like stocks, bonds, and real estate) to reduce the impact of any single volatile event.
By understanding what makes the stock market fluctuate, you can better prepare yourself to face the ups and downs of investing. It’s crucial to approach investing with a well-thought-out strategy and a long-term perspective, keeping in mind that market fluctuations are a normal part of the investment journey.
How Do Market Corrections Impact Your Investments?
Market corrections—typically defined as a decline of 10% to 20% from recent market highs—are an inherent part of the stock market’s cycle. While often unsettling, understanding the impact of these corrections can help you maintain perspective and provide effective portfolio management.
- Short-Term Impact. In the short term, market corrections can lead to noticeable declines in portfolio values. For investors, watching this dip can be stressful, especially if you are not prepared for market movements. However, these corrections are not uncommon and are considered a natural part of market dynamics. Historically, markets have experienced corrections on average every 1 to 2 years. The immediate effect is a reduction in your investment value, but this is typically temporary.
- Long-Term Opportunities. Interestingly, corrections can also present opportunities for long-term investors. Lower prices can provide a chance to buy quality stocks at a discount, potentially setting the stage for significant gains when the market recovers. The key is to have a strategic approach during these times, focusing on solid fundamentals rather than reactive selling. Historically, markets have not only recovered from corrections but have often reached new highs afterward.
- Test of Investment Strategy. Corrections can serve as a test of your investment strategy. They can reveal whether a portfolio is too heavily skewed towards high-risk assets or if it is well-diversified. Investors might find corrections a good time to reassess their asset allocation and risk tolerance. Ensuring that your investment strategy aligns with your long-term financial goals is crucial, especially in handling market fluctuation.
- Psychological Effects. Beyond the financial impact, market corrections can significantly affect investor psychology. The fear of further losses can compel some investors to make hasty decisions, such as selling assets at a low point. Maintaining discipline during these times and sticking to a predetermined investment plan can help mitigate emotional responses that could potentially hurt long-term investment outcomes.
- Reinforcement of Diversification. Finally, corrections reinforce the importance of diversification. By spreading investments across various asset classes, geographic regions, and sectors, you can buffer your portfolio against significant downturns in any single area. Diversified portfolios typically experience smaller fluctuations during market corrections, providing more stability and peace of mind.
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Why Is Trying to Time the Market Considered a Fool’s Game?
When volatility shakes the very ground you tread, many investors are tempted to time the market—attempting to predict its highs and lows—to maximize their returns. However, this strategy often backfires and understanding why can help you make more informed decisions. The major drawback of attempting to time the market is the fundamental unpredictability of stock movements in the short term. As you know, economic indicators, corporate earnings reports, and geopolitical events can drastically sway market directions. The inherent complexity and global interconnection of financial markets mean that even seasoned professionals with advanced tools at their disposal frequently misjudge market movements.
Historical data shows that over a 30-year period, the returns of investors who attempted to time the market were overwhelmingly inferior to those who maintained a consistent market presence. The likelihood of missing out not only on high-return days but also on crucial periods of recovery and growth underscores the gamble inherent in market timing.
What Can We Learn from Historical Market Performance?
Historical market performance offers a treasure trove of insights for both novice and experienced investors. By examining the past behaviors and patterns of markets, we can glean important lessons that help in sculpting robust investment strategies.
Firstly, historical data underscores the resilience of markets over the long term. Despite short-term fluctuations and even significant downturns, markets have trended upward over decades. For instance, the historical annual average return of the S&P 500 is around 10%, including during periods of recessions and recoveries.
This historical perspective advocates for a disciplined approach to investing, emphasizing diversification, regular investing (such as dollar-cost averaging), and maintaining a long-term horizon. These strategies help mitigate risks and harness the growth potential of the markets without falling into the timing trap.
Moreover, staying educated about financial history and understanding the factors that influence market changes can reinforce an investor’s ability to stick to their strategy. It encourages a focus on broader economic indicators and long-term goals rather than reactive shifts in response to short-term market news.
Historical View: How Do Presidential Elections Affect The Stock Market?
What Key Questions Should Investors Consider During Market Volatility?
During periods of heightened market fluctuation, it’s beneficial for investors to reflect on several key questions:
- “Do I have a financial plan with specific goals and a long-term perspective for my investments?” If the answer is yes and your goals remain unchanged, it’s advisable to stay patient and refrain from making hasty decisions.
- “Do I have an emergency fund for short-term unexpected expenses?” If the answer is yes, it’s wise to utilize this fund rather than liquidating investments during a market downturn.
- “Do I need any of my portfolio’s money in the immediate future (tomorrow, next week, next month, or next year)?” If the answer is no, consider reducing your exposure to financial news to lessen anxiety. Remember, history shows that markets generally rebound. Over the last 200 years, U.S. equities have mostly delivered positive annual returns, demonstrating the market’s long-term resilience.
How Can You Stay Focused on Long-Term Goals Amid Market Volatility?
Despite the challenges posed by stock market variability, it is crucial to remain focused on your long-term financial goals and avoid making impulsive decisions based on short-term market movements. Our investment strategy is designed to weather market fluctuations, and we continue to monitor developments closely to make informed decisions that align with your best interests.
For more guidance on how to navigate through stock market fluctuation, download our free guide, “Adjust Your Sails: 4 Tips for Navigating Market Volatility, ” which includes a comprehensive checklist for managing through such times.
If you have any questions about financial planning, investment management, or market fluctuations, or if you would like to speak with our team of CERTIFIED FINANCIAL PLANNERTM (CFP®) professionals, we would be happy to show you how our financial planning process can help you stay on track and achieve your financial goals. Please contact us for a complimentary discovery call at 631.218.0077. You can also send us a message directly.
R.W. Rogé & Company, Inc. is an independent, fee-only financial planning and investment management firm serving clients locally and virtually across the country, with Long Island, New York, and Beverly, Massachusetts office locations. R.W. Rogé & Company, Inc. was founded on a “client first” culture and proudly commits to acting in your best interest as a fiduciary. We have helped clients Plan, Achieve, and Live® the life they want since 1986. To learn more about how we do this, as well as our process, explore our detailed overview of services and approach.
