Planning for Volatility

Tab 1

August 05, 2016

The stock market crash of 2008 shook even the most strategic investors. Major financial markets lost nearly a third of their value, the Dow Jones industrial average dropped more than 50 percent in less than 18 months, and the equities market fell more than 40 percent. This was an extreme example of volatility in the stock market, though it was hardly an isolated event, says Timothy Dreiling, CFA, Regional Investment Director for The Private Client Reserve in Kansas City, Kansas.


“There is always some manner of uncertainty creeping into the market, and uncertainty causes volatility.”


Since 2008, many triggers of volatility have occurred in the market, such as the collapse in the price of oil, the Federal Reserve’s interest rate stance, the Greek economic crisis and the United Kingdom’s decision to exit the European Union. 

Not to mention the impact of elections, slow wage growth and a host of other social, economic and political events that impact the global marketplace.


It’s easy to let events produce fear or lead to impulsive decisions. However, we suggest you keep these recommendations top of mind to avoid “The Cycle of Investor Emotion.”

Tab 2

August 05, 2016



1. Don’t let headlines overwhelm you.

Sometimes, it can seem that the news never stops. Even if events have a relatively small effect on the market, media sensationalism can cause investors to lose sleep, says Elizabeth Jones, Portfolio Manager of The Private Client Reserve in Chicago. “That’s why education concerning long-term strategies and risk mitigation is important.”


2. Expect volatility. When investors see dramatic swings in the market, their gut instinct may tell them to get out while they still can, but that kind of emotional decision-making may do more harm than good, says Daniel Farley, CFA, Regional Investment Director for The Private Client Reserve in Minneapolis.


He notes that while the crash of 2008 was painful to live through, those who stayed the course with a balanced portfolio averaged roughly a 5 percent increase per year over time.1


“It was hair-raising when we were in the middle of it. However, those who waited it out saw their portfolio normalize over time,” he says.


That’s fairly typical, says Jeffrey Kravetz, CFA, regional investment director for The Private Client Reserve in Scottsdale, Arizona.

When you look at the long-term stock market, investors with diversified portfolios who stay in the market have historically and consistently experienced steady gains over time.


The Cycle of Investor Emotion (click to enlarge)


3. Know the effects of market timing. Kravetz points to data on the 20-year annual return for asset classes from 1995 through 2014, which shows investors who held half of their portfolio in stocks and half in bonds averaged an 8 percent return year over year, because stocks averaged 10 percent increases on average, while bonds experienced 6 percent growth


Even though there were points in those two decades where the market fell dramatically, it always bounced back, and those who stayed in the market benefited.


Kravetz says, “History has proven time and again that the long-term performance of any portfolio is better when investors stick to their plan.”

Tab 3

August 05, 2016

Those who panicked and sold all of their assets, on the other hand, would have experienced incredible losses. The old adage “buy low, sell high” is especially true in a volatile market. Equities, for example, are up 200 percent since they bottomed out in March 2009,2 meaning investors who sold off equities missed out on all those gains.


Similarly, emerging market stocks tanked in 2008, causing many investors to categorize international markets as too risky and to abandon them entirely. But they rebounded dramatically between 2009 and 2012, coming out of the crisis better than developed markets. This was due to significant economic growth in emerging markets coupled with a weak U.S. dollar, which made their currencies stronger.


“These examples are illustrative of the importance of sticking to your long-term investment plan,” Farley says. “The problem is not getting out of the market, it’s what you miss out on while you wait to get back in.”


Staying grounded in one’s long-term plan may be the foundation of a strong investment strategy.


4. Know your destination. Having a well thought out, long-term investment plan that translates to a diversified portfolio and is aligned with your financial goals is the best defense against any period of volatility, explains John De Clue, CFA, Chief Investment Officer for The Private Client Reserve.


“It’s not about timing the market, it’s about

time in the market,” he says. You can’t create these plans in response to market volatility.


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Rather, smart investors will work with their investment advisors to determine the best strategy for their investments before getting into the market, so they can build an investment portfolio that accommodates their timeline, financial goals and appetite for risk.


Understanding each of these factors can help any investor and his or her advisors build a balanced portfolio and shape investment decisions along the way, De Clue says.


5. Diversify. Once investors have defined their goals, timeline and appetite for risk, they can work with their financial advisors to establish a targeted ratio of equities to bonds that are diversified among multiple asset classes. 


Typically, a conservative, or low-risk, portfolio will have a ratio of 40 percent equities and 60 percent bonds, while the reverse is considered a classic or moderate-risk portfolio. A high-risk investor might lean toward an 80/20 ratio of equities to bonds, which is considered aggressive.


Investors and their advisors may further minimize volatility by establishing diversity in asset classes to minimize correlation between assets — where like markets rise and fall in relative unison. For example, international market fluctuations often do not correlate to the U.S. market.

Tab 4

August 05, 2016

By combining U.S. and international stocks, investors may balance the currency value of a portfolio. Investors may also combine investments in high-risk tech startup stocks with blue chip stocks that are often considered to be less risky and may offer steady earnings. A good financial advisor can help investors make the best choices to achieve this balance, Farley says.


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"This way, when the next period of volatility hits, one side may benefit with the other is challenged, potentially minimizing the impact on your portfolio," Farley said.


Such diversity can dampen the impact of volatility and make it easier for investors to stick to their plans. It is important to note that diversification and asset allocation do not guarantee returns or protect against losses.


Still, it is important to note that having a well-balanced portfolio doesn’t mean investors should completely ignore their investments when volatility occurs.


A good financial advisor will communicate with his or her clients about what’s happening in the market, says Tiffani Boskovich, Portfolio Manager for The Private Client Reserve in Denver. “A good financial advisor can show you how volatility will impact your portfolio over time, which can help give you confidence that you can stick to your plan,” she says.


A good financial advisor can also identify opportunities to take advantage of volatility while still maintaining the targeted portfolio diversity. For example, investors may want to sell overpriced assets that aren’t justified by the market or buy underweight assets that may increase when the volatile period ends. She points to the

famous quote by Warren Buffet: “When everyone is selling, you should buy.”


But ultimately, De Clue says, such adjustments should be minor and always reflect your broad financial goals, timeline and risk appetite. “Volatility is always going to happen, but it should never impact your long-term investment plan,” he says. “The best response is to stay calm and weather the storm. Eventually it will come to an end.” 




1 U.S. Bank calculation, running a PrimaGuide simulation on a portfolio consisting of 60 percent U.S. equities (represented by the S&P 500) and 40 percent U.S. bonds (represented by the Barclays Aggregate Bond Index). The annualized return on such a portfolio was actually 6.15 percent for the period Jan. 1, 2008, to March 31, 2016.


2 “The Stock Market Drop … by the Numbers,”, Aug. 24, 2015.


There are risks associated with investing. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investments in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in fixed income securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities.


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