Don’t be fooled by low volatility
“Jump on in. The water is fine.”
The picture that comes to many of our minds, following these two sentences, is of some gullible soul leaping into freezing water because someone assured them the water was pleasant. In similar fashion, many unsuspecting investors have been jumping into the stock markets because, quite frankly, the investing waters really have been fine. The economy continues to slowly strengthen, interest rates are rising at an acceptable pace, stock markets continue to hit new highs, and market volatility is near alltime lows.
Market volatility is measured by the Volatility Index or VIX, as it is commonly called. Also referred to as “the fear gauge”, the VIX is listed on the Chicago Board Options Exchange. It is a forward looking measurement that is calculated using option prices, and shows the market’s expectation of volatility for the next 30 days. Currently, the VIX is near its all-time low.
The lack of market volatility, generally, implies confidence in the economic outlook is high. With the state of world affairs these days, such assuredness may seem out of place. However, the headlines which seem most unsettling tend to surround the highly debated state of politics and social agendas, rather than the state of the economy. Regardless of one’s opinion about the president’s politics and social agenda, the markets appear to like his business policies as indexes continue to hit new highs. If the president succeeds in reducing the corporate tax rate, much of the tax savings will flow directly to company profits. Rather than banking those newly found profits, many firms will invest the proceeds back into the business, or pay the funds out as dividends to shareholders.
With peaceful easy feelings washing over the stock market, you may be tempted to plow more and more money into stocks. Giving into this temptation creates the possibility of larger stock market losses than you may want to take or able to afford to take. The solution is to focus on the rate of return you need to hit your financial goals rather than the current rate of return of the stock market. After all, the stock market rate of return reflects a portfolio that is 100 percent in equities, and many investors may not want to take that kind of risk.
There is a very popular radio show that focuses on financial advice. I like the host, and enjoy listening to his opinions as he responds to calls from listeners. His advice on investing in securities, however, seems overly simplistic to me. From what I have observed, he encourages most investors to divide the money they have allocated to stocks and bonds equally among four types of mutual funds including growth funds, growth and income funds, aggressive growth funds, and international funds. The challenge I have with this advice is those styles of mutual funds are often heavily invested in the stock market. The fact is, as investors draw nearer to retirement, many cannot afford to take that kind of risk nor would they want to. I believe you are better off knowing what type of return you need to achieve your own personal financial goals, and investing to hit those returns. If you can hit your retirement goal without taking a lot of risk, then you may not want to invest so heavily in the stock market.
Do you remember what happened to stocks during the downturn of 2001 and 2002? Are you still feeling the sting from losses incurred during the Great Recession of the late 2000s? If so, ask yourself do you want to go through that again? For those who want to reduce the likelihood of taking another major financial hit, it is important to not allow yourself to be lulled by the calmness of the markets.
A volatile stock market might be valued by those who fancy themselves as stock pickers knowing how to time the market. Personally, I would opt for markets with low volatility any day of the week because I have never believed that shortterm trading is a way to secure long-term investment results. Nonetheless, a steady stock market can catch investors off guard. Keep your focus on the portfolio that is right for you, and do not try to compete with the stock market, unless you are willing to accept that kind of risk.
Ken Levy is a Certified Financial Planner professional and a principal with Levy, Daniel & McGee Wealth Management. Wells Fargo Advisors Financial Network is not a legal or tax advisor. Investment products and services through Wells Fargo Advisors Financial Network, LLC (WFAFN) Member SIPC. Levy, Daniel & McGee Wealth Management is a separate entity from WFAFN.