LUTZ BUSINESS INSIGHTS
Putting Volatility in Context
JUSTIN VOSSEN, INVESTMENT ADVISER & PRINCIPAL
Given the volatility of equity markets, many folks desire a quick and easy explanation for the recent movements. Many peruse the headlines to try to find answers. Some say it is China, some the Fed, others say the fall in oil prices has caused the volatility. We all want easy explanations to describe the complex movements of a world economy estimated at $77 trillion in 2014. We have hesitated writing another article for our clients to try to explain away the recent volatility, to reassure that things will be okay. It’s not because we don’t believe that everything will okay, but rather because this volatility is a normal thing for the markets. At Lutz Financial, we prepare for this ahead of time, by making sure clients are diversified and have enough set aside to weather these eventual pullbacks. Pullbacks are not enjoyable, but rather necessary in order to achieve desired returns in the long-run.
Why do I say that? Well, without the threat of losses, the stock market becomes risk free. When something is risk free, its return is minimal, if anything. If stocks never went down and only rose, the stock market would look like the tech bubble of the late 1990’s forever, or more recently the Chinese mainland market. Many would blindly leverage themselves exponentially to purchase businesses that were going public that had never made a single $1 of income throughout their short existence.
We all know that this isn’t right. The stock market is a collection of businesses that ebb and flow with economic cycles. There are many cause and effect relationships that need to be worked through daily as people determine a price for those various businesses. If the dollar rises and oil prices fall, that is generally good for the American consumer who can buy cheaper imported goods with the money they are saving at the pump relative to the prior year. If the Chinese currency falls that is generally good for their exporters, but bad for German exporters whose goods just got relatively more expensive. What about the saber rattling in North Korea who deployed their submarines last week? When is the Fed going to begin raising interest rates? Anyone remember Greece?
When you are trying to determine a value of one stock given all of these assumptions as well as factoring in new data that is changing minute-by-minute, it’s difficult. Now, try to value collectively the more than 100,000 publicly traded companies in the world as events transpire on a daily basis. It’s a wonder there is not more volatility!
Because the world is very noisy and stock markets are open five days-a-week, the noise gets measured in dollars and cents almost by the second. We are going to have many fits and starts, as economic cycles naturally happen and the market adjusts. There will be multiple peaks and valleys, but the general trend-line is that economies expand over long-periods of time as illustrated below.
The majority of us are investors for the long-term, and this gradual growth trend (albeit somewhat bumpy short-term) is where investors generate returns. The noise during the cycle is simply the risk-premium or the reason we get to have above average returns. It is the efficient market’s way for paying you for the near-term unpredictability of equity returns in the shorter-run.
How do we combat that short-term unpredictability? While some think (and are generally unsuccessful) they can time the market cycles, the most effective way to do it is diversification. If you need money in the short-term, don’t let it be subject to short-term volatility or risk. This is why we want clients to have some funds in the lower-yielding bonds and cash (because they are less risky/volatile). We definitely don’t recommend bonds for their great yields! They are to be the risk anchor when the seas are rough.
Finally, what about the people on TV or the internet preaching the impending doom of the economy, a stock market crash of epic proportions and an end to our way of life? The answer to that is simple. Anything, including being struck by lightning or winning the lottery, is a possibility. If I listed out all of the bad things that could happen to me each day, it would be long and terrifying and I would probably choose to stay in bed and hide. It is possible the market could fall another 50%, but given history, not probable. Thus, in life we choose to deal in probabilities, which is why I get into my car each morning and choose to come to work. I don’t stay home because I don’t want to have a car accident. That being said, I am going to wear my seatbelt and drive cautiously on my way to the office to ensure I get there safely! Much like bonds and cash, my seatbelt will hopefully protect me in the event of an accident. However, I must take the risk to drive to work in order to make a living. It’s a calculated risk, much like equities, but one that will reward over time.
Important Disclosure Information
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.
ABOUT THE AUTHOR
JUSTIN VOSSEN, CFP® + INVESTMENT ADVISER, PRINCIPAL
Justin Vossen is an Investment Adviser and Principal at Lutz Financial with over 20 years of relevant experience. He specializes in wealth management and financial planning.
AREAS OF FOCUS
- Financial Planning
- Wealth Management
AFFILIATIONS AND CREDENTIALS
- Certified Financial Planner™
- Financial Planning Association, Member
- BSBA in Economics and Finance, Creighton University, Omaha, NE
- St. Augustine Indian Mission, Board Member
- Nebraska Elementary and Secondary School Finance Authority, Board Member
- St. Patrick's Church, Trustee
- March of Dimes Nebraska, Past Board Member
- Am I Ready to Retire? Finding Your Sweet Spot
- Outsmarting the Ivy League?
- An Investor's Year-End Wrap Up & Tax Prep
- Nobody Knows Anything
- Add "Brexit" to the Long List of Uncertainty
- Financial Planning for College Grads
- Fight or Flight - Lesson Learned
- Social Security: The New Rules
- Putting Volatility in Context
- The Asian and European Fronts
- Bubble Looming or a Bubble Popped
- Re-Emerging Markets?
- A Market Perspective
- Timing is Not Everything
- "Yellen" at the Fed
- Mind What Matters...Focus Efforts On What You Can Control
- What to do With a Financial Windfall
- Love Indexes - Hate the Indexes
- Do I Own a Market?
- A Practical Primer On Volatility
- 5 Retirement Strategies for Small Business Owners
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