Market Volatility May Not Always Equal Market Risk


There is a widely held misconception in investors’ minds (most likely drilled in by the financial media) that market volatility — the current roller coaster ride — always equals market risk. The current uncertainty, brought on by anything from the Greece debt concern, high unemployment, double dip recession, government spending, or (insert concern here) have pulled the markets back around 14 percent from their peak as of this writing. With this temporary pull back comes the clamoring of the financial media that the risk to investors — and some might more accurately say, day traders — is headed back to the lows of March 2009. The inconsistency triggers investors to think…Oh no, here we go again!

However, these thoughts may not occur as often if the average investor understood that market volatility does not always equal market risk…to the long-term investor. Or just allow the advice of Warren Buffett to sink in, who wrote in his 2009 annual report, “We’ve put a lot of money to work during the chaos of the last two years. Those who invest only when commentators are upbeat end up paying a heavy price for meaningless reassurance.”

Allow me to explain further. Market volatility may be the thing that will help get the long-term investor through retirement. But by hoping away volatility, the investor may be removing growth potential. The reason equities (stocks) have historically provided better returns when compared to other assets classes, such as bonds or cash, can be directly related to its volatility (and the ability of some money managers to capitalize on this volatility).

Let’s step back a moment and break it down: If an asset class doesn’t have, or has very little, volatility, its price movement becomes more correlated to a fixed asset, such as a bond. Given this historical correlation, we need to keep in mind that the average retired couple — retiring at age 65 today — has a much longer life span (perhaps three decades, or longer). In addition, the realization that their cost of living will continue to rise throughout those three decades means, in my opinion, that the only rational conclusion is that they need market volatility of an asset class that can provide the potential of buying low and selling high. This would provide the potential for growth necessary to maintain their lifestyle with the rising cost of living. If you still doubt me, take a look at the cost of a U.S Postage stamp in 1946, at the dawn of baby boomers, and look at it now. In 1946, a U.S. postage stamp was 3 cents. Today, it stands at 44 cents…this is real life chewing away at purchasing power.

Conversely, many investors go into retirement knowing that they have a set cost to cover and feel uncomfortable with the volatility that equities brings. As a result, they place too much money into fixed assets because they feel better today. What they don’t understand is that they are potentially losing purchasing power — over what could possibly be three decades of retirement. Why? A fixed investment portfolio lacks the potential for growth typically required to keep up with the rising cost of living. And this is one of the real risks of retirement…outliving one’s income. I know what you are thinking: Did he just tell us to place 100 percent of our funds in stocks during retirement? The answer is NO, I did not say that. You need to speak to your advisor, preferably a CERTIFIED FINANCIAL PLANNER, to build the correct diversified portfolio that matches your goals. However, I believe your retirement portfolio should have some equities as a component of the overall mix.

The newly acquired knowledge of these simple facts, that market volatility may not equal market risk, and understanding the difference between the two, will hopefully allow the average investor to stomach the coming ups and downs the markets will bring, as well as welcome them. With this, I leave you with one more quote from Buffett (hey, if your going to quote someone…quote the best), “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” And that’s all I got to say about that (Forrest Gump).

Past performance is no guarantee of future results.
This article was written by Lou Melone, Managing Partner, with Budd, Melone & Company in Auburn Hills, MI. Lou Melone can be reached at 248.499.8704.
Posted date on Article IV, Issue I
Dated 7.10.2010
Wells Fargo Advisors Financial Network did not assist in the preparation of this article, and its accuracy and completeness are not guaranteed. The opinions expressed in this article are those of the author and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.
Budd, Melone & Company and Wells Fargo Advisors Financial Network do not provide tax or legal advice.
Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuation
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SIPC. Budd, Melone & Company is a separate entity from WFAFN.