October 12, 2011
Five Reasons You Should Not Panic in the Face of Market Volatility
1. It is not really “different this time.” Vanguard, in a recent study entitled “Stock Market Volatility: Extraordinary or ‘Ordinary’?”, concludes that recent volatility appears extraordinary compared to the relative calm of the markets in 2010, but is in fact “ordinary” when compared to similar periods characterized by major global macro events – they cite the Asian currency crisis of 1997, the Russian debt default and bailout of Long-term Capital Management in 1998, the tech market bubble (2000-2002), and of course the financial crisis of 2008-2009. Market volatility spiked in similar ways during each of these events as markets tried to re-price risk in the face of startling new information. This time it is political paralysis and the European sovereign debt crisis. So the reason is different, but the market reacts to crisis in similar fashion, over and over again.
2. Diversification provides a remarkable amount of protection from volatility. Information in the charts below is taken from the same Vanguard study mentioned above.
3. The only way to fully participate in the up days is to be able to withstand the down days. Volatility refers to moves in both directions.
4. Remember that you are investing and not trading. “Sitting out” the current volatility is an appealing notion, but timing the market is something better left to speculators and traders. Trying to benefit from correct predictions of short-term moves in the market is not a long-term investment strategy.
5. “The market has been volatile and just dropped dramatically – what do I do now?” This is a bad question and bad questions do not lead to good investment decisions. A better question would be, “Am I still taking an appropriate amount of risk considering my goals and time horizon?”
Sticking to your disciplined investment strategy is a better response than panic. When stock prices tumble and bond prices soar, it provides an opportunity to rebalance your portfolio by taking some profits from the bonds and buying stocks at reduced prices.