The Harmlessness of Volatility

…and the fact that it may actually be your investing friend!

Volatility is not risk.

Volatility = Characterized by or subject to rapid or unexpected change.

Risk = The possibility of loss.

Volatility causes many investors to panic. As frustrating as it may become, volatility should not cause panic and may, in fact, be looked upon as an investor’s friend.

To illustrate volatility, per an exquisite narrative by Nick Murray, since post-WWII:

  • There were 65 complete calendar years from 1946 through 2012. The S&P 500 Index, considering price only, and giving no effect to dividends, rose in 46 of the 65 periods, or 71% of the time. Over the entire period, the S&P went from 18 to 1400.
  • The earnings of the Index rose from $.94 to $77.35, and the dividend from $.67 to $22.73.
  • The Index return with dividends reinvested averaged 10.55% per year.

But during that timeframe, note the relentless and often quite horrific volatility that occurred:

  • The average intra-year decline in those 65 periods was 14.1%.
  • Hence declines of 10% or more have taken place on an average of once per year.
  • Declines of 15% or more have taken place on an average of once every three years.
  • Declines of 20% or more have taken place on an average of once every five years.
  • The average peak to trough decline of the 13 bear markets was 30%.

Again, despite relentless and horrific volatility, over the entire period, the S&P 500 went from 18 to 1400. Imagine the numbers with the added power of regular, systematic investing, just like you do every pay period in your 401k. (Source of statistics: yahoofinance.com, politicalcalcualtions.com and Standard and Poor’s).

The lesson is to 1) Understand volatility, 2) Embrace volatility, 3) Ignore the media’s screaming about volatility and, 4) Do not allow volatility to cause you to panic out of your diversified portfolio, which may cause you to derail your carefully crafted long term Financial Plan.