Wading through the hot and cold market volatility pool

RSM McGladrey


You’ve probably heard the expression that if you have one foot in cold water and the other in hot water, on average, you’re OK. So, OK may be the average, but it isn’t a comfortable feeling.
However, to get comfortable, you might need to add cold water to the hot or hot water to the cold or need to take your feet out of the buckets all together. But what does any of this have to do with market volatility? Well, just like changes in water temperature, volatility means ups (too hot) and downs (too cold) in the market.Let’s look at one market, the S&P 500 —--- the index of the largest U.S. stocks. For the 12 months ending March 31, 2007, the S&P is down -7.15 percent, which has put cold water on many investors. During this 12-month period, the volatility between the highest point and the lowest point is 17.22 percent. Or, in other words, there’s been too much hot and cold water this year and now it’s cooler than last year.Since 1925 there have been 82 calendar years through 2007. Twenty-three calendar years with a negative return, the rest (59) positive. From a historical perspective, the S&P 500 is up 72 percent of the time. For the calendar year 2007, the S&P 500 was up 5.49 percent. To put that in perspective, the greatest loss was -43 percent in 1931, the greatest gain was almost 54 percent in 1933 —--- that’s a lot of cold and hot water.When it comes to market volatility, time is considered a diversifier. If you relate time to buckets of water, consider what happens when the buckets are set out for awhile: They begin to warm or cool to the room temperature (think of room temperature as “average”). Now, look at a 10-year average of the S&P 500. From 1925 through 2007 there have been 48 -10-year periods. The greatest loss was a 10-year period ending 1938 at -.89 percent; the greatest gain was 20.06 percent in ending 1958. As time is taken into account, the average returns of the S&P 500 begin to blend toward a historic average of approximately 10 percent.But remember — this is an example of just one market. A portfolio should consist of more than one market — it should be several markets strategically mixed together to provide a well-balanced allocation. Additional markets include international, small companies, emerging markets and bonds — among others. The reason? Markets may behave differently in relation to each other as the economy changes. So, when one market is in cold water another may provide hot water and vice versa.Generally, a portfolio should be structured to meet client goals and needs, usually resulting in required rate of return over a given period of time. Money is placed into a portfolio that is allocated between equities and fixed income securities and diversified through sub-asset classes such as large company stocks, small company stocks, international company stocks, government bonds, municipal bonds, etc. Regardless of the time perspective, the risk tolerance needs to be identified. This is similar to knowing the temperature sensitivity. Some people like it hotter and others like it colder. That return may have volatility over a short period of time. Since time and diversification can reduce volatility, occasionally giving a portfolio a chance to work through time will provide the return necessary to fulfill goals, needs and objectives. So what should you do as an investor? If you’re uneasy with your portfolio, visit with your wealth management advisor. The time spent will assist you and your advisor in understanding your desired portfolio risk (you wish the water temperature was this), needed portfolio risk (the water should be this temperature) and any rebalancing (adding hot or cold water) necessary to maintain your objectives. David Hardinger, CFP®, ChFC, MSFS, CASL is a director with RSM McGladrey Wealth Management. For more information, contact him at david.hardinger@rsmi.com.