Volatility is Coming, How Will Your Portoflio Hold Up?

Volatility, which measures how stock prices jump around, has been relatively low lately. But depend on this: It will surge again, once the market goes through turmoil. We are overdue for that. There is only one way to survive the next bout of volatility – with cold blood.

The French call this quality sangfroid. Unless you need to cash in your stocks for some reason, like retirement, don’t let these gyrations faze you. Let’s explain why this makes sense.

Two emotions drive markets: fear and greed. Fear always triumphs over greed.  While fear can drive people out of markets, it can also force them to buy. Fear and greed represent the two key ingredients driving increased volatility.

Specifically, here’s how to look at it without going crazy or losing sleep:

What is the volatility situation right now?

Volatility refers to the fluctuation in price from one period to another of a particular investment or a stock index like the Standard & Poor’s 500. The amount of volatility is often described via the Volatility Index, which measures the fluctuations in the S&P 500 and is often simply called the VIX. This metric merely shows the pricing for options, which investors use to protect themselves against stock price swings.

The greater the price people are willing to pay for protection, the higher the implied volatility. The VIX spiked in October 2008 during the financial crisis, and later climbed in 2010 and 2012 amid worries over Europe’s stability. For the past two years, it has been at a low ebb.

Is your portfolio volatile?

A measure known as beta tracks how volatile your mutual fund is. It often refers to the volatility of the S&P 500 index relative to that investment. If your security or fund has a beta of 1.0, then it has the same volatility as the broad market. If your mutual fund or stock has a beta lower than 1.0, it is less volatile than the index. Higher, more volatile.

What can you do to reduce volatility in your portfolios?

Many academics tell you that diversification is the only remedy. You don’t need have all your money in any one stock, asset class or even all in equities. The more you diversify assets, the more you can tame the effect of volatility.

When does volatility matter most?

Undoubtedly, volatility during distribution is most concerning. Average returns do not matter as much as reduced volatility when you begin to pull money out of your investment accounts for income. You saved in your 401(k) and individual retirement accounts not to have a large balance, but rather to have an income at retirement. The only thing that can separate you from your retirement dreams as quickly as the Internal Revenue Service is volatility. Then, you are forced to sell at an unattractive price to generate income.

Is volatility always bad for your returns?

Not at all – if you are in a period of preservation where your nest egg is much larger than the amount you are continuing to add. If you aren’t anticipating using your assets currently, then volatility is like a roller coaster. Some rides end better than others, but it is far less scary when you don’t need to sell at a particular time.

As we look at the markets the shift in volatility was somewhat expected from our vantage point. The economy shows both encouraging and discouraging data, the Federal Reserve is a wild card and the world appears to be in chaos. Yet the bull market remains, for now.

Follow AdviceIQ on Twitter at @adviceiq.

Written by Joseph “Big Joe” Clark, CFP. Joseph Clark is the managing partner of the Financial Enhancement Group LLC, an SEC Registered Investment Advisory firm in Indiana. He teaches financial planning at Purdue University and is the host of Consider This with Big Joe Clark, found on WQME and iTunes. He is a Registered Principal offering Securities and Registered Investment Advisory Services through World Equity Group, Inc, member FINRA/SIPC. Big Joe can be reached at bigjoe@yourlifeafterwork.com, or (765) 640-1524. Follow him on Twitter at @Big Joe Clark and on Facebook at http://www.facebook.com/FinancialEnhancementGroup.

Securities offered through and by World Equity Group Inc. Member FINRA/SIPC. Advisory services can be offered by the Financial Enhancement Group (FEG) or World Equity Group. FEG and World Equity Group are separately owned and operated.

AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.