Knowing How to Navigate the Volatility of Markets Matters
Let’s talk about investing for beginners in times of volatility. Oxford Languages defines volatility as:
“liability to change rapidly and unpredictably, especially for the worse.”
One insight almost anyone can make about the stock market is that short-term returns are unpredictable. Volatility—especially the possibility of downward trends—should be a part of the retirement planning process (and one of the things a retirement calculator doesn’t necessarily tell you). When we discuss investing for novices, it’s important to help investors understand the full impact recessions and bear markets can have on a portfolio. Any investor feels like a pro when the markets are climbing, but sooner or later volatility kicks in and markets sell off.
Bear Markets Cause Uncertainty & Unrest
Most people have at least heard of bear and bull markets. A bear market is a prolonged period of price declines in the stock market. Investopedia elaborates:
“It typically describes a condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment.”
For an investor that notices the impact a bear market has on their portfolio for the first time, it can be unsettling. Bear markets most often happen during or as a result of slowing economic activity, otherwise known as a recession.
For the Inexperienced Investor, Recessions May Make Investing a Challenge
The problem with recessions is that earnings decline, while P/E multiples decline at the same time. When these two metrics both decline, a significant market decline (drawdown) may occur. (See our “Investing in Stocks” article for a simple explanation of the P/E multiple).
In the post WWII era, the worst drawdown occurred between December 2007 and June 2009, when the S&P 500 index declined -57%. The second worst drawdown, a -49% decline, happened between March 2001 and November 2001.
Understanding Your Risk Tolerance is a Key Step for Any Investor
In sports, top athletes use a technique where they visualize themselves winning a particular competition. Try using this method to test your investment risk tolerance. Do some quick math and visualize what a 57% decline would look like on your retirement portfolio. How would you feel about it? Sure, most markets have bounced back eventually, but remember the math of market declines. A -50% decline requires a 100% return just to get back to even. So, after 2009, a -57% decline required a +132% return to get back to even. That’s a difficult reality when you’re considering how it could impact your hard-earned retirement savings.
Conversely, a -10% decline only requires a little over +11% to get back to even. So, the concept of diversification is your ally in times of economic recessions and bear markets.
Diversification May Help You in Bear Markets & Recessions
Diversification is especially important when it comes to trying to protect an investment portfolio from the kinds of declines or “drawdowns” that can significantly alter your goals and objectives.
For starters, make sure you fully understand your own risk tolerance and the impact that higher equity allocations may have on your long-term goals. It’s important to review these foundational basics periodically, whether you’re a beginning investor or more seasoned.
This material is provided by Schmitt Wealth Advisers for informational purposes only. Schmitt Wealth Advisers does not provide tax or legal advice, and nothing herein should be construed as such. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. Opinions expressed by Schmitt Wealth Advisers are based on economic or market conditions at the time this material was written. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from publicly available sources (unless otherwise noted) and are believed to be reliable. Schmitt Wealth Advisers, however, cannot guarantee the accuracy or completeness of such information. Past performance may not be indicative of future results.