Few things stoke as much fear in stock market investors as volatility—that is, how often security prices rise or fall, and by how much. Consider the financial media’s sensationalism when covering market pullbacks and corrections: It’s as if their use of the word “volatility” is intended to scare investors. One commonly cited volatility measure, the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), has even earned the nickname "the fear index." But is volatility really the enemy the media purports it to be? We don’t think so. As with most things investment-related, understanding volatility can help investors overcome their fear—and can create opportunities for those who are able to endure it.
At a basic level, stock market volatility is simply the degree to which investments’ prices fluctuate over time. Every security’s price rises and falls over time, and these movements may occur quickly or slowly depending on the security’s type, sector or issuing company. In the short term, securities can swing in unpredictable ways, and this unpredictability can unnerve investors. But as you begin to look over longer periods, higher returns can reward investors who tolerate short-term market volatility.
In markets, responding purely to volatility can be folly, an inherently backward-looking decision. Volatility today tells you nothing about how volatile markets will be tomorrow. While volatility is simply a measure of movement in the market, there are different ways to measure it.
Historical volatility, also known as "realized volatility,” is a statistical measurement—generally an annualized standard deviation—of price movement over a specific period. These calculations include both upward and downward movements—something many overlook as they associate volatility with risk of loss. In fact, historical volatility can actually be very valuable in evaluating the risk/reward ratios of potential investments over a variety of time frames. For example, look at our chart below. As it illustrates, a portfolio of all low-risk bonds (as represented by US 10-year Government bond) is likely to show much less historic volatility than a diverse portfolio of all stocks (as represented by the S&P 500) over a 10-year period.1 This may lead conservative investors to assume bonds are “safer,” but the story changes when looking over a longer time span. When observed over 25-year periods, the stocks are likely to have both a higher rate of return and less deviation from that rate than bonds.2 As noted below, the volatility associated with equity portfolios lessens over longer periods relative to portfolios weighted with more towards fixed income. Assessing historic volatility, asset allocation and time horizon relative to return can be useful in guiding your asset allocation decision as retirement nears.
Beta is a way to compare the correlation of your portfolio and its components to that of a chosen market index. However, beta only shows how much something moved (note: past tense) relative to the market—backward-looking and unhelpful in assessing future volatility or performance.
Markets can be challenging for investors to navigate. Learning to overcome the anxiety associated with short-term market movements is a key to achieving your goals. The longer your investment time horizon, the less impactful short-term volatility will be on your portfolio. Understanding how to think about volatility can aid you in selecting the best options for you.
If you’re still feeling uncomfortable with volatility, consider working with Fisher Investments. Our experienced research team has a deep understanding of market risks relevant to client portfolios, and dedicated Investment Counselors are available to help guide you through times of increased market volatility and keep you on the path to your long-term financial goals. Request an appointment for additional information on our services, or download one of our many informative guides for more insights on investment strategies.