When it comes to investments, the old saying, “the trend is your friend”, is absolutely correct. An investor who holds a well-diversified portfolio designed to align with that investor’s unique risk profile would almost surely be very satisfied by the annual return provided through that portfolio. A great example would be an investor with a portfolio that allocates 60% to equities (a mix of domestic and international) and 40% to fixed income would have fared exceptionally well since early 2009 (see Slide 1 in the Screen Show). The slide shows that the S&P 500 Index has maintained a steady uptrend over the past four years!
However, for all those who were invested in equities between 2007 and 2009 do not have any difficulty remembering how scary it was to hold stocks through the beginning months of the “Great Recession” (also known as the “Mortgage Crisis”). As you can see from Slide 2, the S&P 500 Index plummeted 42% between August 11 and November 20 of 2008! That felt like riding straight downward on a financial roller coaster. However, the decline was not yet over, since the market did not reach bottom until March of 2009, after falling a further 6% (total decline over 48%!).
Therefore, a great (albeit un-poetic) corollary to “the trend is your friend” would be “volatility will drive you crazy and give you sleepless nights!” There are many ways to measure and identify stock volatility. However, a common way is through the use of the VIX Index (measuring the volatility of the S&P 500 Index). Slide 3 shows the pattern made by the VIX during the same period during 2008-09 that we used to demonstrate the scary price action in the S&P 500. If you imagine the VIX chart directly above the S&P Index chart, you’ll note that the volatility spikes peak when the S&P moves most widely.
Needless to say, therefore, “Volatility” is always a concern for the average investor – particularly since we witnessed two classic periods of oversized volatility between 2000 and 2010 – the “Dot.com Bubble” and the “Great Recession”. That is why I approached Merrill Lynch executive and financial expert, Steve Diltz regarding how you can manage volatility in stocks without expending undue time adjusting investments every week.
Look for Part II, where we will share Steve’s insights and suggestions regarding how to more effectively manage investment volatility!