Market Volatility – How to Enjoy the Ride

The Orient Express. This was the name of a roller coaster at Worlds of Fun in Kansas City, MO from 1980 to 2003. Standing at 117 feet high with a 115 foot drop this steel beast threw brave riders around like rag dolls. Cars rattled along her tracks at break-neck speeds; feelings of nausea, excitement and terror blurred together like the park landscape beneath her rigid frame. If that wasn’t enough to turn a rider’s world upside down she literally flipped them upside down with two inverted loops and then finished off would be conquerors with the first ever double loop called the Kamikaze Curve!

When the train finally pulled into the station you could see a mixture of emotions on people’s faces as they stumbled from their seats. Some were elated; their excitement evident on their smiling faces. They had made it and they were ready for more. Other passengers, however, looked like they wished they had taken the Chicken Exit when they had the chance. That crazy ride was more than they could handle.

• “Worst Crisis Since ‘30s, with No End Yet in Sight,” Wall Street Journal, 9/18/2008
• “Global Economic Shock Worse Than Great Depression,” Huffington Post, 5/8/2009
• “Financial Crisis is the Worst the World has Ever Faced, “ Daily Telegraph, 10/7/2011

The Great Recession of 2008. Big job cuts, bigger bailouts and subprime mortgages popping like bubble wrap being run over by a flaming garbage truck. For many investors this market crash redefined the meaning of market volatility. GDP fell 4.3% during this time (www.federalreservehistory.org) and the stock market crashed more than 50% (www.thebalance.com) when all was said and done. Day after day headlines similar to the ones listed above flashed on every media news outlet. The financial sector was falling faster than the Orient Express in a vertical dive causing many investors to throw up their hands screaming. At the time it seemed like that ride would never end.

But it did.

If you had invested $10,000 in a mutual fund that was geared towards growth at the end of the Great Recession — with no additional contributions, no distributions and dividends reinvesting automatically — your investment portfolio would be worth roughly $72,000 today. That’s an average annual return of 16%. Not too shabby. But I’m guessing the thought of throwing money (let alone $10,000) into a market that had been doing continuous Kamikaze Curves for over a year would have made the average investor more than a little queasy. Today I’ll share some truths about investing to help you stomach the ups and downs of the stock market so you can invest with confidence.

Now, the lawyers want me to let you know that no investment strategy can guarantee positive returns, historical performance is no indication of future performance, and securities are not FDIC insured. They aren’t wrong, but I’m here to tell you – no risk, no reward. So, if the thought of losing even one dollar has you breaking out in hives, stop reading right now. Chicken Exit is on your left. However, if you’re ready to experience the exciting, sometimes scary, unpredictable world of the stock market then climb on board and buckle up. You’re in for a wild ride.

Truth #1 – There is no such thing as “risk-free” investing.

Everything has risks. Everything. FDIC insured savings account? Interest rate risk. CDs and bonds? Liquidity risk AND interest rate risk. Money shoved under your floor boards at home? Natural disaster risk, home invasion risk, oh, and termites! Yeah! They like money too.

Risk can only be managed not eliminated. So when we look at traditional investments, such as stocks and mutual funds, you need to balance the risk to our portfolio with the potential for returns that you’ll be satisfied with. I remember working with two sisters years ago who had inherited equal amounts of money. They each opened accounts at roughly the same time but invested very differently. One sister invested aggressively in the stock market and selected investments that were high risk. The second sister was more conservative in her investment choices and selected less risky investments. Time went by and the second (conservative) sister came into the office upset because her portfolio had performed “poorly”. We reviewed her portfolio and it had performed within expectations and had earned a modest amount of returns. She had made money. When asked why she was upset about having positive returns her response was, “My sister’s portfolio earned more than mine.” The first sister had assumed more risk and reaped the rewards. Keep in mind, in a down market the pendulum could easily have swung the other way. When you select quality investments that have higher risk you have the potential for higher returns, and if you select a less risky investment you should also expect lower returns.

ACTION: Manage risk. There are many investment options available, even for the conservative investor, so choose investments that you’ll be comfortable with in ALL market conditions.

Truth #2 – You need to be okay with the ups and downs.

The Great Recession was a severe market crash that shook the train cars of even the most seasoned investors. The market bottomed out on March 6, 2009 with the DOW closing at 6,469.95 points. Since then it has recovered to over 35,000 points which sounds fantastic, but it wasn’t a straight line up. During the past 13 years the DOW has had at least a dozen stomach flipping dips with analysts trying (and failing) to anticipate the next “big crash”. And while the uncertainty of the market can wreak havoc on your zen, understand that discipline and clear financial goals are what it takes to come out ahead when facing market volatility.

When the market starts moving down is not the time to panic. That’s the time to review your portfolio, consider your financial goals and make decisions based on your timeline. An investor who is 25 years old and doesn’t plan on retiring until they’re 65 has a long timeline and can ride out a down market. If you’re 70 years old and taking income from your portfolio, moving to a more conservative investment strategy may be a prudent course of action since your portfolio won’t have “time to recover” from a drop in the market. However, you want to carefully consider your goals, needs and overall financial situation before making any changes.

ACTION: Don’t panic – PLAN.

Truth #3 – Good investors think long-term.

This is not your savings account. This is NOT your savings account. This is NOT YOUR SAVINGS ACCOUNT.

This is your investment portfolio. You are an investor with the financial goal of accumulating wealth for a specific purpose. Do not invest money you’re going to need. There are few things more unsettling then seeing your portfolio value drop 20% knowing that that’s all the “extra” money you have. This bucket is not for going on a shopping spree, buying new tires for your vehicle, or to help “make ends meet”. If you want to build an investment portfolio your “ends” need to be overlapping not just meeting. Whether it’s for retirement savings, buying a new home, or just because you’ve got mad termite love for money, it means being willing and able to hold the investments you purchase for at least a year or longer.

ACTION: Establish an Emergency Fund. These are funds in a conventional bank account that are used for unexpected expenses with a balance of at least 3-months of your average living expenses (6-months if you’re married). Your Emergency Fund is for safety. You wouldn’t get on a roller coaster without a seat belt so don’t invest in the stock market without an Emergency Fund.

Truth #4 – You’re probably going to lose money.

Before you go running towards the Chicken Exit let me explain. At some point you’re going to have “unrealized” losses. This is when your investment portfolio value falls in relation to what you paid for it. As long as you don’t sell out and the security doesn’t go to zero (companies do fail) then your loss is “unrealized” – your statement might look like the final scene in Scarface, but you’ll still have the potential to recapture your principal (and possibly some gains) if that security rebounds. However, if your portfolio value is down when you decide to sell then you have a “realized” loss. No recovering from that. So, your choices are to ride out the rough spots or bail mid-dip. Either way expect your hair to get wind-blown.

You might also experience my favorite type of loss which I call the “woulda shoulda”. Years ago I considered buying Netflix* but the $20 price per share seemed too expensive. I rationalized my reluctance to buy the stock because I thought, “Nobody watches DVDs anymore. This company is going nowhere!” Well, today Netflix is trading around $400 per share. **cough**cough** WOULDA SHOULDA!

There are many twists, turns and upside down moments in the life of an investor, but the goal is to pull into the station safely with more than what you started with. Keep in mind sometimes that’s not necessarily more money. My lesson with Netflix is that I needed to do my research. I assumed Netflix was sticking with the dying DVD rental business and I didn’t anticipate their business model evolving into what it is today.

ACTION: Count your winnings or learn your lessons. Then, onto the next investment.

*I do not own shares of Netflix and this is not a recommendation to buy, sell or hold the security.

Truth #5 – Investing isn’t for everyone and that’s ok.

Investing in the stock market is not one size fits all. While it may seem tempting when you’re talking about a hot new stock with your friends or co-workers the reality is not everyone can tolerate market volatility. If you’re the kind of person who is going to lose sleep worrying about their investment portfolio then the market isn’t for you. You’re not tall enough to ride this ride.

ACTION: Follow your gut, not the group. As I stated earlier, there are other options available for conservative investors. While the potential for returns may be less, you can’t put a price on a good night’s sleep.

In Conclusion

Market volatility is a natural part of investing in the stock market. You can’t avoid it nor should you want to. Can you imagine riding a roller coaster that moved in a straight line and only had a couple of bunny hops along the way? How boring! The drops, turns and flips can be unsettling, but that’s also when things get interesting. Downturns in the market are prime buying opportunities for investors who are looking to purchase quality investments at a bargain price. Remember, when the market gets rocky do not be discouraged or make decisions based on emotions. Focus on your financial goals and enjoy the ride.

Financial Fancy Talk 101

Have you ever heard someone ask, “How’s the market doing today?” It’s a broad question that refers to the DOW or any combination of the DOW, NASDAQ or S&P 500 but most often the DOW.

“The Market”: Also called the stock market or equity market. This is where investors go to buy and sell securities of various kinds. Investors can access the market through online trading platforms, a financial advisor, through a broker dealer, or even through employer retirement plans (investment options may be limited). It does not refer to fixed income securities like CDs, bonds or treasuries unless specifically stated (i.e. “How’s the bond market doing today?”).