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Financial Sense: Stock market volatility management

By Jason Glisczynski

The term “stock market volatility” refers to how rapidly the markets move up or down.

Historically speaking, if the markets are “doing well,” volatility is low, and the markets are moving positively most days. This is sometimes called a “bull market.” You may have a few negative days in the mix, but not a bunch of negative days in a row. The down days are not huge—1-3 percent—and the up days are not huge either, 1-3 percent. When volatility is high, that means the markets are swinging more wildly, having 3-5 percent days or even greater in EITHER direction.

Another way to put it is, that low volatility is a simmering pot and your noodles are cooking nicely; high volatility is a rolling boil spilling over the pot and all over your stove. Now, why is this important?

We have all been told “the stock market performs over long periods of time at 8-10 percent per year on average, depending on what resource you are looking at. This historical measurement is over the ENTIRE history of the market which is over 100+ years.

So, who cares if the markets are volatile sometimes? I’m certain your investment timeframe is less than 100 years, so the “history of the market” has little meaning. What really matters is how the markets behave during YOUR investment timeframe. If it evens out over a relatively short term like 25-30 years, why should you care? The answer is simple: You shouldn’t—unless of course, you plan to withdraw your money in the next 5-10 years, and here is why: When we experience periods of high volatility (large swings) and you try to take money out to live on, you could be selling low which can greatly reduce how long your nest egg will last.

This problem is known as “sequence of returns risk” and “reverse dollar cost averaging.” What that means is if you get poor returns at the wrong time such as when you are trying to take money out early in retirement, it can have DRASTIC results on your long-term outcome. The other challenge we face is with the “historic 8-10 percent return of the markets” statistic.

In 1966, the Dow Jones Industrial Average hit 1,000 points; an all-time high. In 1982, the Dow Jones was at 1,000 points. Sixteen years of up and down, good years and bad years but essentially no growth. In 2000, the markets hit a peak but after the tech bubble popped and the ’08 financial crisis; fast forward to 2013 and we are at the same level as the year 2000. For thirteen years the market returned 0 percent.

Now I know what many of you are thinking, “Jason, I made money in my 401k or other accounts during that period of time, so why does this matter to me?” The reason is simply that if you were working during that period of time, and putting money in, you were BUYING when the markets were low. If you were retired during this time, you would be SELLING when the markets were low. This is why having a strategy to control volatility is important if you are within 10 years of your desired retirement date or already in retirement.

There are several methods to lower volatility. You can actively trade ETPs (exchange-traded products) that combat volatility or use minimum volatility ETFs (Exchange Traded Funds) such as iShares® Smart Beta series. This may result in lower returns in certain environments, but many studies have shown that an investment account with a high rate of return with high volatility while withdrawing funds will give you a poorer result than an account with a lower return and lower volatility.

Jason Glisczynski is co-owner and principal advisor for Silvertree, LLC. Investment Advisory
Services are offered through Brookstone Capital Management (BCM) LLC, a Registered Investment Advisor. Silvertree LLC and BCM are separate companies. Visit www.silvertreeplan.com for more information.