Road Cents - Planning for Volatility
By Michael Woods, CFP, CIM
Walter and Winnie Bago are long-term investors as they expect to live for another 15-20 years in good health. While they do their best to ignore the day-to-day and even month-to-month moves in the equity markets, it has been hard to miss the recent headlines while passing the TV in the clubhouse of their winter resort. Walter’s Arizona golf partners are telling him to sell everything, while Winnie’s bridge partner is telling her it is a great time to buy. Walter and Winnie wonder what is causing the volatility and if it will continue. They also want to know what they should do, if anything.
It is not unusual for markets to experience bouts of volatility, and the causes can vary with the weather. In the current environment, one can point a finger at many culprits: slowing economic growth in China; a weak banking sector in Europe; governments around the world facing high debt levels and lowering their currencies to increase exports; energy companies facing defaults; and the potential for knock-on effects as a result of all of the above. When investing, there will always be something to be worried about, and with the introduction of computer systems that trade securities using algorithms, and billions of dollars invested in Exchange-Traded Funds (ETFs), volatility is on the rise. These two factors provide retail and institutional clients the ability to trade buckets of investments in a flash based on news that will be forgotten a week later. With the current concerns showing no signs of abating, and technological “advancements” continuing, it would not be surprising for increased volatility to become the norm.
Armed with this knowledge, Walter and Winnie need to decide whether or not they can endure volatility in retirement, and the decision needs to be based on their comfort level. They know that their portfolio is set up to withstand economic and market shocks; they have five years of income needs in short-term liquid investments, and the rest of their portfolio in a combination of fixed income and equities. With this portfolio structure, they are probably best to ride out the storm. But, just because their portfolio can handle pressure does not mean that Walter and Winnie want the mental and emotional strain.
Even before markets become volatile, investors like Walter and Winnie need to have a long-term plan in place. While the plan should be based on hard numbers and conservative return expectations, it must be noted that emotions are a reality of life and need to play a role in planning. While allocating a set percentage of assets into the equity market to produce a projected return may have sounded fine when preparing their plan, Walter and Winnie need to take a hard look at their past emotions to determine if that equity allocation is reasonable. If they have a history of getting nervous during volatile periods, then maybe they should reduce the equity allocation in their plan and accept the lower projected returns. Under this scenario, they are more likely to remain calm during rough seas and avoid the temptation to act on a knee-jerk reaction that could impact their finances over the longer term.
Michael Woods is a Portfolio Manager At Odlum Brown Limited.
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