What’s your tolerance for stock market volatility?
The question may be better asked, “What is your tolerance for market volatility?” or, “How volatile are your investments?” Perhaps a better understanding of market volatility might help. When observed in very minute detail, the short-term performance history of investments in the stock market closely resemble the path of a thrilling roller-coaster ride – many unpredictable ups-and-downs and sharp turns in every direction. This unpredictability is what creates the market’s penchant for volatility. If we could accurately predict the size and timing of the markets’ movements, then there would be no uncertainty, and no volatility. However, the higher returns that have accompanied this enduring environment of volatility would probably vanish. As return potential increases, so does the volatility and risk. This is the paradox by which market volatility has been defined. An investment’s performance potential is usually directly correlated to that investment’s volatility. As the return potential of a specific investment grows, the likelihood that the investment could experience a loss of principal correspondingly increases. The short-term performance history of investments in the stock market closely resemble the path of a thrilling roller-coaster ride many unpredictable ups and downs with sharp turns in every direction. This unpredictability is what creates the markets’ penchant for volatility. If we could accurately predict the size and timing of the markets’ movements, then there would be no uncertainty and no volatility. However, the high returns that have accompanied this enduring environment of volatility would probably vanish. As the potential for high returns increases, so does the risk. This is the paradox by which market volatility has been defined.Volatility is also used to define the severity by which an investment tends to fluctuate, which is often referred to as market risk. Investments that tend to experience greater changes in value over time are said to be more volatile, while those with a lower tendency to fluctuate are said to be less volatile. What factors have the greatest influence on an investment’s volatility?Generally, an investment’s classification is determined by its level of volatility. Fixed income or cash based investment funds are said to be the least volatile, while small cap and international stock funds are said to be among the most volatile. Between these two classes are bond, large- and mid- cap stock funds and funds that combine characteristics from each of these classes. Because the rate of return on fixed income based funds tends to be lower, they are generally more susceptible to inflation rate risk, the risk that future investment returns will barely keep pace with the cost of living, otherwise known as inflation. This is especially true when income taxes on earnings and appreciation are considered. Small cap and international stock funds have the greatest uncertainty, making these funds the most volatile. These funds contain stocks of new and growing companies and economies. A lack of long-term performance history may apply to some small-cap stock and international stock funds, which can be subject to currency and political risks. Bond, large- and mid- cap funds are generally a bit more predictable. In the case of bond funds, market interest rate changes can have a dramatic effect on performance. Large- and mid- cap stock funds’ performances tends to follow that of the given industry in which companies compete, so economic and social trends can greatly influence performance.
How can you help protect yourself against the effects of volatility over the long-term? Consider diversification among the different classes of investments. Of course, there is no way to guarantee against losses, which may even occur in the most diversified portfolio of investments. However, diversification should help reduce your overall risk. Other things to consider when investing are: your investment time horizon, which is the amount of time you have to accumulate and invest assets, and your risk tolerance risk, which is a measure of how comfortable you are with ongoing investment risk. As you are reviewing information that will help you make investment decisions, please keep in mind that past performance is never a guarantee of future results.To get a clearer understanding of how market volatility can affect your investment portfolio, speak with a financial professional who can explain the intricacies of the different investment classes and help you map out an investment strategy that best suits your needs and objectives. Jeffrey Apps & Tracy Tutag offer securities and investment advisory services through AXA Advisors LLC (member NASD, SIPC) 1290 Avenue of the Americas, New York, NY 212-314-4600 and offers annuity and insurance products through an insurance brokerage affiliate, AXA Network LLC and its subsidiaries. They can be reached at 926.6911 or firstname.lastname@example.orgVail, Colorado
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