The stock market in January experienced significantly increased volatility. In the first 14 trading days in January, the S&P500 declined about 12.5% on an intraday basis. This could be categorized as an “average” correction and was likely overdue, given the strong stock market performance of the last two years.
One thing to keep in mind is that volatility is normal. It is an inherent feature of the public financial markets. In fact, volatility is a necessary element to the higher returns generated by the stock market. History shows that investors who are willing to withstand higher portfolio volatility can expect a higher rate of return.
Inevitably when volatility increases like it has recently, anxieties for clients may increase regarding their investments. And the concerns are appropriate.
For most of our clients, their life savings and ability to achieve their financial goals are closely tied to the long-term performance of their investments. In this context, one of the most important things a good financial planner can do is to impart discipline for the client not only for their investments, but also other key elements of their financial plan such as budgeting, goal setting, tax and estate planning, and cash flow management. All of these elements work together to support a financial path in which the client can feel confident, including his or her investment portfolio.
As part of a financial plan, a disciplined approach to investments can greatly help to allay client anxieties or concerns during bouts of market volatility.
There are several reasons for this. First, a disciplined investment strategy will include diversification across several asset classes, such as U.S. stocks, international stocks, bonds, real estate, and commodities. Holding multiple asset classes helps to dampen portfolio volatility.
Second, appropriate asset allocation is an important discipline that refers to the percentage of assets in the various asset classes. Asset allocation is determined by the needs of the client as set forth in his or her financial plan and represents a strategic positioning of assets that should not change based on the vagaries of the financial markets.
Third, having a disciplined approach to investing obviates the need for trying to “time” the market. Market timing, or trading in and out of the market based on guesses on what the market may do, is probably the biggest destroyer of long-term returns for both individual and professional investors alike and can seriously undermine an otherwise sound financial plan.
Knowing their investments are properly positioned in a disciplined manner can and should go a long way to allaying client fears during volatile periods. An appropriate asset allocation will do the job of delivering the long-term returns within, ideally, the lowest risk posture necessary to achieve the goals of the plan. By adopting this disciplined approach, clients need not worry about the short-term effects of market volatility and are better positioned to stay the course in delivering more predictable long-term return on their assets with lower overall risk.
Robert Toomey, CFA/CFP, is Vice President of Research for S. R. Schill & Associates on Mercer Island.
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