October Fright: What Volatility Might Mean to You

October can usher more than a chill in the air. It can turn investors downright cold at the thought of their exposure to the stock markets.

And for good reason: October historically has seen dramatic market declines. In fact, half of the top 10 worst days (in percentage terms) on the Dow Jones Industrial Average occurred in October, with the Black Monday crash of Oct. 19, 1987, topping them all. That day’s 22.6% freefall left many people nervous and confused about what to do next.

But here’s what makes October perhaps even more intriguing and confounding. Half of the top 10 best days in market history on a percentage basis also occurred in October. Not coincidentally, 4 of those 5 occurred either just before or just after 1 of the top 10 worst days.

“That’s the very definition of volatility,” said Joe Correnti, senior vice president of brokerage product at Scottrade. “It’s not just movement in one direction or another. It’s movement up and down, making it extremely difficult for investors without a plan to figure out their next move.”

The Impact of Volatility on Performance

There are 2 ways to look at the practical effect of this kind of volatility: short-term and long-term. Short-term, big declines can be disconcerting. For example, a diversified stock portfolio valued at $100,000 on Oct. 20, 1987, was likely worth something less than $80,000 by the end of the next day.

“What these huge one-day losses show is that if you need money in the short-term, you probably shouldn’t have those funds exposed solely to the stock market,” Correnti said.

Viewed through a longer time horizon, however, the 1-day declines don’t look nearly as menacing. The day after the 1987 crash, for example, the Dow (and all other U.S. stock indexes) began moving back up. .

“It took about two years, but long-term investors who had a plan and stuck to it saw their stock portfolio recover,” Correnti said.

The Psychological Impact

In retrospect, riding out the volatility could have been a good choice for long-term investors in 1987. However, many panicked and sold at the wrong time – when the market bottomed out.

“It’s a well-known phenomenon that individual investors will see much lower returns than the market itself, because they tend to let emotion drive their decisions instead of sticking with their plan,” Correnti said. “Fighting the urge to panic or make snap decisions during a period of high volatility is difficult, but may be necessary to commit to a long-term plan.”

Dealing With Volatility

Volatility and the markets are a given, but there are 2 general approaches that might be able to help offset the effects of bouncing market prices on your portfolio.

  • Consider diversifying with lower correlated assets. This essentially means limiting your exposure to any  one kind of asset (like U.S. stocks). Contemplate including in your portfolio assets that don’t move in the same direction, or move in the same magnitude, as other assets. Bonds, for example, typically don’t follow in lock step with stocks.
  • Understand trading tactics. Many traders actually look forward to volatility, believing that they can capitalize on short-term movements or opportunities. We won’t go into details here, but you can see more details in a previous blog post, 6 Ways to Help Protect Profits and Minimize Losses.

Question: Are you more likely to panic or stay the course when volatility hits?

Next Step: Are you worried so much about a market decline that you’re afraid to invest? Check out our Investment Calculator, which can help you determine the impact of  investing later, rather than today.

Disclosures

Keep in mind that while diversification may help spread risk it does not assure a profit, or protect against loss, in a down market.

The information and content provided is for informational and/or educational purposes only. The information presented or discussed is not, and should not be considered, a recommendation or an offer of, or solicitation of an offer by, Scottrade or its affiliates to buy, sell or hold any security or other financial product, or an endorsement or affirmation of any specific investment strategy. You are fully responsible for your investment decisions. Your choice to engage in a particular investment or investment strategy should be based solely on your own research and evaluation of the risks involved, your financial circumstances, and your investment objectives. Scottrade, Inc. and its affiliates are not offering or providing, and will not offer or provide, any advice, opinion or recommendation of the suitability, value or profitability of any particular investment or investment strategy.

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