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One of the stranger paradoxes in finance is volatility — the degree to which an asset’s price swings up or down over time. Most investors hear the word and flinch. But once you understand what volatility actually is, and what it makes possible, you might start to see it very differently.
Think about it this way. A savings account is about as predictable as it gets, your money sits there, safe and stable, and grows at a modest rate. No surprises, no drama. But that predictability comes at a cost. The returns are so low that for most people, saving alone will never build the kind of pot needed for a comfortable retirement. You’d have to put away enormous sums just to get there.
This is where volatility enters stage left. The very reason stocks, property, and other investments can deliver far greater returns over time is precisely because their prices move around. That uncertainty, the chance that things could go down, is exactly what creates the opportunity for them to go up significantly. Investors are essentially rewarded for tolerating the bumps in the road.
In other words, volatility isn’t the enemy of your wealth. It’s the engine that creates it.To my mind, volatility gets such bad press largely because of how it feels at the moment. When markets drop, it triggers something deeply uncomfortable in us, an annoying voice that says “get out, get out now, otherwise we’re all doomed!”
This is our ancient survival instincts doing us absolutely no favours in a modern investment context. Our brains were not exactly designed with a 30-year retirement horizon in mind — they’re more comfortable thinking about clubbing that furry critter over the head for dinner. And the hunt was never predictable. Some days you came back loaded, some days you didn’t. That unpredictability felt like danger, because back then, it was. The intellectual ape never quite got the memo that sometimes the wisest move is to sit still and wait.
In reality, Volatility is essentially that friend who shows up to the party, knocks something over, and suddenly everyone’s questioning whether they should have been invited at all. But that same friend is also the one who always comes through when it matters. They’re just a little chaotic in the short term.
The investors who build real wealth over time aren’t the ones who avoided volatility, they’re the ones who stopped flinching at it. They understood that a portfolio going down 15% in a bad year isn’t a disaster. They might feel a bit green watching everything turn red. What matters is staying the course long enough for the recoveries, and the growth beyond them, to do their work.
So the next time markets get choppy and every headline is screaming panic, remember: volatility isn’t a flaw in the system. It’s a feature. Your slightly chaotic, occasionally alarming, ultimately indispensable best friend. And without it, we’d all be stuck comparing savings account rates and dreaming of a retirement that takes a lot more money to achieve without volatility riding to the rescue.
Volatility is one way active market players can make money with a degree of confidence. Some good companies that are volatile still have fairly recognizable peaks and troughs. And people who track these companies can do really well over time if they buy during known troughs, and sell during peaks, as long as they don’t get too greedy. While markets shocks can interfere, slow and steady in stable markets can pay off when one takes profits in smaller bites.
Mark, thanks for another thoughtful article.
Basically along the same lines as you, I get very frustrated when people use the words “risk” and “volatility” interchangeably.
My own personal way of viewing risk (which I’m sure is not technically correct) is the probability that at the end your investment period, returns will be below a particular threshold level. Volatility along the way doesn’t matter, as long as the return by the end meets your base level expectation.
Greg. I really think people get confused because they simply can’t wrap their head around the difference between risk and volatility. Years ago I read something like this about the difference. Volatility is like a stormy sea, it’s a rough ride, but the ship is fine. Risk is a hole in the hull, the ship is actually going down.
I feel the same way – stock market volatility is not necessarily risk – it depends on goals and timeline.
I think alot of this stems from a lack of understanding about what risk is and how to assess it. My definition of risk is anything that could prevent you from achieving your goals. This means before you can assess risks you need a goal (what do you want to achieve and when?) and a plan (how are you going to get there)? to achieve that goal. Only then can you really start to assess risk (what could go wrong?) and mitigate it.
For investors with long term goals – volatility is truly an opportunity. In that situation the biggest risk isn’t the volatility itself but one’s adverse emotional response to it. Once you learn to control that instinctive fear of a market downturn or understand the root cause of that fear and address it, you will be in much better shape.
Mark, thank you for a thoughtful post. I liked your framing of volatility not as something investors must avoid, but as something that long-term investors inevitably live with—and, in some sense, must accept as part of the process.
One challenge, I think, is how the financial services industry frames risk. Many investors are implicitly led to believe that market returns behave like a tidy normal distribution. That assumption shapes expectations to our detriment.
In reality, extreme market moves occur far more frequently than a normal distribution would suggest. The classic example is the 1987 Black Monday crash. Under a normal distribution, a move of that magnitude would be something like a 20-sigma event—statistically expected once in a billion years. Yet it occurred within the span of modern market history. And importantly, the distribution of returns isn’t symmetric: large downward moves tend to occur more often than large upward ones.
Given that reality, yes, the only workable strategy is accepting volatility and structuring a portfolio that can tolerate it over very long horizons—not just 10 or 20 years, but often 40+ years.
Diversification across uncorrelated asset classes is also important, but equally important is resisting the urge to constantly measure the portfolio’s value. Unfortunately, the media environment—and modern technology—push us in the opposite direction. We can check our portfolios every minute if we want to. Limiting how often we look may be one of the simplest but most effective forms of risk management available to us individual investors.
Mark, the 1987 Black Monday crash is a fat-tail event that a handful of researchers have built entire careers around. Fortunately, although I was invested at the time, my portfolio was small enough that it barely registered. I think your most insightful point is the simple observation about how frequently people check their numbers — and how technology makes it all too easy to do so. Our fellow contributor My Time to Travel has the right idea: benign neglect. It’s certainly served me well over the years.
I totally agree with looking at the balance daily or weekly is an emotional and possibly a portfolio management detriment. But I’m grappling with the trade of periodic (e.g., one a year) rebalancing vs. opportunistic rebalancing in retirement.
Suggestions?
Most financial articles say rebalance at most semi-annually or annually.
For me and my wife I calculate both our portfolio and net worth, and reallocate quarterly. This is to generate enough cash for one year’s expenses while we wait to collect Social Security at 70.
When we claim Social Security I will switch to semiannual or annual rebalancing to maintain two years cash needs. While this may seem odd, our cash needs will be minimal as our SS and my small pension will cover most, if not all of our annual expenses.
When I turn 73 and I have to take RMDs this should provide enough cash annually to exceed our needs. At that point I will most likely rebalance only annually and increase our equity allocation significantly.
To address your question about opportunistic rebalancing I will increase our equity position by 5% when there is a correction, and 10% overweight when a bear market occurs, then sell 5% when the market returns to a bear, then the other 5% when the market reaches a new high. Now in fairness I have only done this for the last two or so decades so the opportunities have been few and the returns to new highs have been fairly quick.
Good detail on your methods, David…thanks.
Lots have been studied and written on the subject (will be interested in reading what Mark C publishes to HD).
I’m looking at a potential rebalancing rhythm like this: at the end of April after tax season and again in October (6 months later) and then maybe a final adjustment in December for end of year tax considerations and prep for the following year.
With that said, peeking at my portfolio “often” and keeping an eye on the markets for opportunistic rebalancing and/or Roth conversions will also be on the agenda.
I include a Kitces article, circa 2016 but still relevant, I think.
https://www.kitces.com/blog/best-opportunistic-rebalancing-frequency-time-horizons-vs-tolerance-band-thresholds/
Andy, funnily enough, I’ve recently finished writing a forum post called “The Anatomy of a Threshold Rebalance” — what are the chances! I’m planning to post it sometime during the week. It’s written from my own personal experience, but hopefully you’ll find it useful too.
I was originally going to share it on Monday, but your Warren Buffett comment on my other article sparked an idea for a different post — so that one’s jumping the queue and getting posted today. I don’t want to flood the forum with multiple articles within a few days 😂
Mark you are an unbelievable source of articles. I can only think of posting what I think are interesting articles I have read.
Awesome!
(Added comment to David’s comment)
I started investing in equity mutual funds about 6 months before the big crash in 1987. Much like you, with little invested at the time, and being in my mid-20s, I was too busy to worry about it. Over the years, I saw volatility as a huge friend and helper to my dollar cost averaging.
Mark, Jonathan could have penned this timely post; he often referred to our ancient instincts. As you mentioned in a prior post, these can be good times to rebalance investments in order to position them for greater growth coming out of a decline. (see, I was paying attention). Volatility also underlines the importance of having a cash/bond position sufficient to ride out the storm.
Dan, that’s high praise — though I’ll confess, re-reading it after posting I spotted a punctuation mistake. Jonathan would never have let that slip through! (Did you notice it too?)
Speaking of Jonathan, something else he said came to mind: there are very few original stories in personal finance — the skill is making them feel relevant and fresh in the moment. Wise words.
Agree, very nice article
You have a valid point. However, I think we need to consider the difference between the accumulation phase of investing and the preservation/withdrawal stage. In the later stage taking advantage of or in some cases riding out significant market dips is not that easy and for many scary.
Personally I can’t imagine having my entire or great majority of retirement income subject to that roller coaster even though I realize people employ strategies to minimize the risk.
Your pension has probably insulated you from what most people experience in the markets day-to-day — and I mean that without any criticism. When you’re genuinely exposed to volatility, you have no choice but to develop tools to smooth out the short to medium-term gyrations. Most seasoned investors do this with a combination of cash equivalents and bonds.
Personally, I could draw on my cushion for at least 12 years before being forced to sell into a depressed market. I’m at peace with the opportunity cost that entails. Not everyone has the capital base to build that kind of runway — I get that — but any runway is better than none.
I hear you, trying my pension I have a significant amount of cash and bonds, but not for the same reason you do. However, I still find it unsettling when I see a $40,000 drop in one day.
It is possible to have a more conservative portfolio and still be invested in the stock market. Utilities, telecom, and consumer staple stocks are still pretty steady.
Lots of people feel as you do, but, as you know, the reality is that most retirees living without the safety net of a defined benefit pension have no choice but to live with market gyrations. Having said that, there are effective tools for the masses to avail themselves of, if they choose.
Good article Mark. Here is a simple math equation I use in volatile market times:
Volatility = Opportunity
How so?
When markets go down it is an opportunity to do two things:
1) Buys stocks at a discount- you can either invest cash in stocks, or rebalance.
2) Convert more shares of your traditional IRA to a Roth- You can convert more shares as each share costs less. As an example if you want to convert $1000, if shares are $100 you can only convert 10 shares. If shares are $50 you can convert twice as many shares.
I took advantage of this concept during COVID, the tariff tantrum, and am doing so now. I am converting shares of my wife’s target date fund which contains both domestic and international stocks (the latter of which dropped 3-7% yesterday) and bonds. Once converted the shares will be sold and then I will purchase only Vanguard Total World (VT). I just have to hope that the markets will be depressed for a week or two to complete the plan. If not this procedure was going to happen anyways only over the course of this year, and not at a discount.
Of note is the last two opportunities have unfortunately occurred due the actions of primarily one person.
You’ve hit the nail on the head. When equities drop, a simple rebalance back to your target asset allocation, using your short-term bond allocation to do so, is a sensible approach. Meanwhile, during any period of downward volatility, you can draw on your cash allocation for day-to-day living expenses.
That’s assuming we’ve all been sensible enough to have a cash stash set aside for exactly that scenario… which I’m sure everyone has. Right??
It’ll take more of a drop to trigger a Roth conversion from me, but in principle I agree with you.
All I have done is move two months of conversions forward.
Ah. That may make more sense than my waiting until the market goes down enough to suit me.