Market volatility is an indicator of the variation in the prices at which securities trade in the market, often measured by the standard deviation of returns or a measure of the variance of possible returns from the mean.
Stock markets can experience episodes of volatility at any time, both on the ups and downs. Sometimes, large or dramatic price swings can cause investors to make impulsive investment decisions. However, from a long-term perspective, these short-term deviations can level out until they outline a different trend over longer periods. Based on our analysis of the markets, this trend has historically resulted in favorable equity returns over the long term (for example, in periods with a duration of more than 20 or 30 years).
Fearing market volatility is completely normal, and times of change and uncertainty can be extremely challenging. Nonetheless, price fluctuations are often unpredictable and can end quickly. Trying to predict market timing, avoiding episodes of negative volatility, is an almost impossible operation, with which you risk penalizing your returns over the expected investment horizon. It is also important to remember that market swings are not necessarily synonymous with negative volatility. Sure, downside swings could erode the value of your investments, at least in the short term, but upside swings can still benefit your portfolio.
In fact, for many equity investors, negative volatility is the price they pay to capture long-term returns from the markets. As difficult as it can be to maintain composure and discipline in the face of ups and downs volatility, it could be this very resolve that determines or undermines the achievement of your financial goals. If you fall into the category of investors who struggle to maintain discipline during times of market volatility, you may want to hire a financial advisor who understands your long-term goals.
Keep calm and carry on
Even the most seasoned investors can make counterproductive decisions with bad timing for their portfolio. For example, deviating from a well-thought-out long-term strategy to focus on stocks that perform favorably in the short term can prove to be an ill-advised tactic, which could ultimately hinder the pursuit of one’s long-term goals.
Even bullish markets are subject to bouts of volatility, and it is rare to see uninterrupted price growth over the long term. As stock prices rise, fears and volatility are completely normal. Bull (or rising) markets often overcome many fears during their life cycle, a phenomenon we refer to as the tendency to climb the “wall of fear”.
Upon the occurrence of certain events, such as geopolitical tensions, elections or natural disasters, equities may face short-term price swings triggered by rising levels of uncertainty. Fortunately, these types of events often lack the scale or severity needed to trigger a bear market (a market downturn of at least 20% in size), so it’s important to maintain the right discipline to weather the storm.
Bull markets tend to experience one or more corrections (a fear-driven sharp decline of between -10% and -20% within a larger bull cycle). Such corrections are usually based on psychological factors or false fears, not fundamentals, and tend to be temporary. While they are common during bull market cycles, there are many investors who lose course due to these phenomena.
Discipline is more important than timing
Since corrections tend to be based on fear, and can begin or end for any or no reason, trying to predict them can be a futile exercise. Reacting emotionally to recent stock price swings could expose you to losses by buying and selling stocks at the wrong time. For example, worries about a steep market downturn could cause you to sell short, running the risk of missing out on the next bounce. More often than not, the best decision you can make during a correction is simply to hold onto your investments to ensure you reap all the returns the bull market offers. Similarly, if you buy a particular stock following a period of recent outperformance, you may find yourself overpaying for it, buying it just before it hits lows again. Investment management is often a time-consuming business, and discipline is more often than not more important than the timing of the market.
