New record highs were reached at the end of August as the S&P 500, the benchmark index which tracks the 500 largest companies in the U.S., closed above 2,000 for the first time.
Volatility in individual stocks and in the market can work to an investors advantage, said Bill DeShurko, a portfolio manager on Covestor, the online investment management company and president of 401 Advisor, a registered investment adviser based in Centreville, Ohio.
“Without volatility, there would not be the opportunity to acquire stocks at low prices,” he said. “Market volatility is always the friend of the patient investor. Studies show that when you buy stocks is very important. For an income and value strategy, buying into positions at a low price is imperative.”
Market volatility can be beneficial for investors who contribute to their retirement plans regularly such as a 401(k) plan, said Joe Jennings, investment director for PNC Wealth Management in Baltimore.
Whenever the market is down, investors have an opportunity to “buy low” and participate in the market's appreciation over time.
“For any investor who has established the discipline of periodic portfolio rebalancing, dips in the market also afford an opportunity to rebalance via ‘buying low,’" he said. “In this respect, volatility should be viewed as creating opportunities for investors.”
Higher market volatility tends to reflect a decline in the stock market, said David Lyon, CEO of Main Street Financial, a Chicago-based registered investment advisory firm. When volatility increases, the amount of risk increases and returns decrease.
Lower volatility typically corresponds to a higher probability of a rising market.
During periods of high volatility, irrational responses by investors can increase losses, he said.
“The average investor typically returns less than the returns of the funds that they are invested in because of investors trying to time the market and making emotion-based investment decisions,” Lyon said. “For disciplined investors who stay invested and make consistent contributions, high volatility can provide areas of opportunity to lower their cost basis and over the long term make greater returns.”
Average investors should refrain from actively monitoring their retirement account, because it results in inherent behavioral biases, said Robert Johnson, professor of finance for the Heider College of Business at Creighton University. In bear markets, investors often get “very scared” and move assets from equities to bonds or money market securities. Likewise, in bull markets, investors often get very overconfident and move money from bonds and money market securities to stocks.
“Unfortunately, investors tend to follow a herd mentality,” he said. “They end up ‘buying high and selling low’ exactly because they do monitor their investments. An investor’s target asset allocation should not change because of market conditions.”
The reason volatility can be good for an average investor's portfolio has to do with the premise, which was originated by Ben Graham, the father of value investing, of buying assets at lower prices when other investors sell them at discounted prices versus their underlying ability to generate cash, said Yale Bock, a portfolio manager on Covestor, an online investment management company with offices in Boston and London.
“An investor can take advantage of these situations by buying the stocks of companies which have a long track record of growth in cash flow, net income and operating income or when the underlying assets of a company are not being given credit based on stock price,” he said.
Since owning equities can benefit an investor for several generations, when a volatile market occurs, consumers should take a look at their favorite companies and research their stocks, Bock said.
While investors can take advantage of periods of high volatility in the market because of the potential for quick returns, the power of long-term investing brings greater yields, said Elle Kaplan, CEO of New York-based LexION Capital Management.
“Compound interest is the real magic of investing,” she said “Over a long enough time frame, the markets always trend upwards, so volatility becomes more or less irrelevant. When it comes to investing, time is your most valuable asset.”
Good investing is not necessarily about completely avoiding volatile investments, but rather building a diversified portfolio that manages your overall level of volatility, said Anthony Criscuolo, a certified financial planner with Palisades Hudson Financial Group in Fort Lauderdale, Fla.
“The more volatile an investment, the greater the chance that its return in a given period will vary from the owner’s expectations,” he said. “Volatility tends to be much greater over short periods compared to long periods.”
During a natural business cycle, investments will increase and decrease in value based on macro-economic conditions.
“It's completely normal and healthy for economies to expand and contract overtime and this creates volatility in the markets,” Criscuolo said.
The best strategy is to maintain a well-diversified portfolio and rebalance back to a target asset allocation based on your risk tolerance and financials goals. Investors can manage their overall volatility by owning a mix of both low volatility assets such as bonds and higher volatility assets such as stocks, he said.
“As markets go up or down you periodically rebalance back to your target allocation,” Criscuolo said.
When stocks go down relative to bonds, you sell bonds and buy stocks, therefore ‘buying at the bottom.’ When stocks go up, you sell stocks and buy bonds, thus ‘selling at the top.’
“Of course you are not always or really ever selling exactly at the top or buying exactly at the bottom,” he said. “But with this strategy you are managing your volatility over the long-term and using the ups and downs of the market to your advantage.”
Implementing this strategy in the long run should produce better investment results than trying to buy only low volatility investments or by trying to time the markets, Criscuolo said.
“Timing the market is basically impossible, especially over multiple cycles,” he said. “Instead, managing your volatility through diversification and taking advantage of normal volatility and market cycles by rebalancing will produce superior results over the long-term.”
Volatility creates opportunity for long-term investors because it can help them accumulate a larger share of the market, said Kurt Cambier, senior partner at Centennial Capital Partners in Littleton, Colo.
“As markets become more volatile, it creates an opportunity to buy market share on the dips,” he said.
What investors should be focusing on is market share, not the market price, Cambier said.
“It’s the market dislocation that helps the investor find the biggest opportunities to buy the positions they may want at a discount,” he said. “The truly insightful investor looks at market volatility and the market dips that come with them as an opportunity to own a larger share of the market. It goes back to the old saying buy the dips sell the rips.”
--Written by Ellen Chang for MainStreet