If you are an individual investor, or if you have ever met with a financial adviser, I am sure you are aware of the concept of volatility, the tendency of investments to move up and down quickly. It’s likely that you’ve heard of it in a negative way, as something to be avoided. The numbers, however, show that if you are investing for the long-term, as most people do, volatility is something you should embrace.
When times get tough, investors tend to call their advisers more than when things are going well. When that happens, for example, advisers can point out to you that your portfolio is “only” down 10% when the S&P 500 is down 12%. Then when things are going well, most people are happy with, say, a 20% return on a year, even if the overall market has gone up 25%.
That’s not necessarily a bad thing. For one, it enables advisers to talk people off of the ledge and not make a bad decision to sell near the bottom of a move down. For long-term investors, staying invested is the most important thing, so that is a benefit. But if you are rational enough to understand that selling out in a panic is not a good idea, even in the face of fluctuation in the value of your holdings, then it makes sense that more volatility is, in fact, a good thing.
Over time, stock values increase. That is not an opinion, it is a simple fact. It is an essential component of an inflationary economic system, which history has shown is the most effective system for encouraging growth and wealth generation in the long-term. And logically, if stocks will inevitably increase in value over time, those that move more will increase more, even if they show bigger short-term losses on moves down.
As you get closer to cashing out your investments, such as when you’re ready to retire, the calculus shifts. That is when it makes sense to reduce the volatility in your portfolio to protect against a big downswing just when you need to access the value in your investments, but if that time is still many years, even decades away, volatility is your friend, not your enemy.
I am not saying here that every investor should run out and invest only in the most volatile stocks, indices, and products available. That would not make sense if you have a relatively short time left until you will need the money, nor if you would find the inevitable down periods extremely stressful. If, however, you understand the nature of volatility in advance and have a long-term investing strategy, then don’t be afraid to include more volatile investments in your portfolio.
The value of investments, and any income from them, can fall and you may get back less than you invested. Tax treatment depends on the individual circumstances of each client and may be subject to change in the future. Neither simulated nor actual past performance are reliable indicators of future performance. Information is provided only as an example and is not a recommendation to pursue a particular strategy.