Investor Education – Volatility Versus Risk
By: Curt Stowers
I make it a point to AVOID AT ALL COSTS speaking with my clients about the “risks of investing.” Some people are going to read this and cringe and wonder what sort of “snake oil” I am peddling. None at all—I’m simply helping my clients to appropriately frame the VOLATILITY of the stock market.
My Two Unshakable Beliefs
At the core of my investment philosophy are two unshakable beliefs:
- Twenty years from now the world’s population will be larger than it is now.
- Twenty years from now the world’s economy will be larger than it is now.
Based on these two beliefs, the only logical conclusion that follows is that the world’s equity markets will be larger/higher in value. The historical data has shown this to be true.
But What About the Skeptics?
Now the skeptics out there are going to site some pending disaster on the horizon that is going to turn all of what we know to be true on its head. OK, that would mean two things:
- These skeptics have accepted the truth about the past and accept that it SEEMS my hypothesis/belief is accurate, but “this time it is different” (the dumbest phrase in existence BTW).
- Some crisis is going to occur that totally reshapes our way of living.
Newsflash folks – if we get a crisis that causes our world population to shrink massively, you better hope you have access to a bunker, a lot of food, and a lot of weaponry! Furthermore, there is not a financial planner around that would to be able to help you navigate that scenario.
Long Horizon – So Why Are You Worried Today?
That brings us to the key question:
- If your investment horizon is twenty years, and you know that the market is going to go up (under our assumptions), why are you worried about the drop in prices today?
Because our “lizard brain” associates the short-term pain of a market drop with an irrational belief that this drop will “last forever.” Basically, folks, we are wired for survival, our investments are our perceived life line, and we freak out when we see them drop. All this is in spite of us knowing that things will recover.
Why Do People do the Wrong Thing (When They Know Better)?
I have yet to meet the person who disagrees with the above assessment of how things will play out. BUT I have met MANY people who still do the absolutely, positively wrong thing and get out of the market when they experience volatility. They let their feelings get in the way and make decisions that are costly beyond belief by “getting out” at exactly the worst time—which is when a market correction / downward volatility exists.
That is why it is so important to frame things in terms of risk versus volatility. Just “knowing” that the drop is going to be short-lived is often enough to help calm people’s nerves and allow them to survive the pain of seeing portfolios shrink in value.
Does this mean that we NEVER need to worry about volatility in the market? Absolutely NOT! As you approach the point in time where you will need to withdrawal funds from your investment portfolio to fund your retirement, volatility needs to be explicitly factored into your financial plan.
Three Levers that Can Protect You in Retirement
Here are three levers that are normally available to protect you in retirement:
- The ability to adjust your spending
- The percentage of equities in your portfolio
- The size of your portfolio
What this means is that you need to make sure your investment portfolio is appropriately constructed to support your desired lifestyle. That is why you will repeatedly hear me emphasize the need for an explicit Investment Policy Strategy (IPS) that outlines these key topics.
What You Should Do – 4 Key Actions You Can Do Now!
Let’s close things down with 3 key points to remember and 4 key actions that—in my opinion— you should do based on the points discussed today:
- REMEMBER: The world equity market has been on a long-term upward trend and, based on the two assumptions I presented above, should continue to follow that trend.
- ACTION – Quit thinking of risk and start thinking of volatility! You KNOW what is going to happen.
- REMEMBER: You are going to be uncomfortable when you experience volatility.
- ACTION – Accept this as a fact. Yes, it effects all of us, as we all have “lizard brains” that worry about our survival. HOWEVER, realize—and remember!—that acting on these feelings when it comes to investing is a very, very bad thing.
- REMEMBER: Your portfolio is something to SUPPORT your lifestyle and is NOT worth anything in and of itself.
- ACTION – Take the time to assess what is important to you in terms of faith, family, friends and fitness and design a life around these things.
- ACTION – THEN figure out how to implement an IPS to support the life you want to live!
Thank you for sharing a bit of your time with me this Friday.
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Photo credit: Andrew Bui on unsplash.com
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