By: Lyn Alden
As we enter the fourth week in August, volatility has returned to the markets.
Month-to-date, the I Fund is down about 0.8%, the C Fund is down 1.6%, and the S Fund is down a full 3.5%. The F and G funds are both up a fraction of a percent.
This year has been one of the lowest stock market volatility years on record. The last few months in particular have tested absolute rock-bottom historical volatility.
Here’s a chart of the volatility index since inception:
The last two weeks, however, have reached the highest measurement of volatility in all of 2017.
It began when tensions with North Korea were heightening, and then just as that was beginning to quiet down, the Charlottesville violence, the president’s response, the subsequent dissolution of the president’s manufacturing council due to multiple CEO resignations kept it back up.
Even still, despite the recent rise, volatility is on the low side historically. It’s important for investors to not become complacent with a smooth-sailing market. Significant volatility will inevitably return at some point; maybe right around the corner, or maybe not for a while. But eventually it will. The debt ceiling limit in October could provide a catalyst for significant volatility, for example. And it’s important to have a plan in place for what you will or won’t do whenever volatility seriously returns.
For example, volatility tends to spike high during recessions or significant market drawdowns. Pulling money out of stocks after the fact, when they’ve already fallen by quite a bit, is a good way to ensure poor returns over time.
This is why the lifecycle funds are good investment choices, despite a small number of drawbacks. They automatically re-balance, and therefore as long as you leave your money in them, they generally make good “decisions” for you.
When stocks get expensive, the lifecycle funds sell some of the stock funds to buy more of the bond funds to stay at their target allocation. And then, when stocks fall, the lifecycle funds sell some bonds to buy some of those cheaper stocks, again to stay at their target balance. If U.S. markets go up a lot, the lifecycle funds will sell some of them and buy some cheaper international stocks. And if international stocks outperform U.S. equities, the funds automatically trim their foreign exposure and invest in more U.S. stocks.
Because the lifecycle funds are essentially operated robotically, they act with Spock-like discipline to buy low and sell high at all times.
This is important, because most investors do the opposite. According to research performed by Dalbar Inc. and graphed here against the long-term performance of various asset classes by JP Morgan, the average investor achieves far worse returns than a simple buy-and-hold indexing strategy:
Holding a pure stock portfolio has historically resulted in good long-term returns, but is highly volatile. A 60/40 split of stocks and bonds that is automatically rebalanced is far less volatile but performs almost as well. Down at the bottom of the performance list, most investors perform as bad as just staying in cash.
As we go forward, make sure you’re not among those investors. It’s important to have a plan and stick with it.