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Don't Freak Out About Market Volatility

Written by Preet Banerjee

Thursday, February 8th, 2018

The headlines screaming around the world at the beginning of the week of Feb 5, 2018 were dominated with these words: "Dow sees biggest one-day point drop in history!"(The "Dow" refers to the Dow Jones Industrial Average, one of the two most often cited stock market indices for the US, the other being the S&P 500).

Should You Freak Out?

Absolutely not. Here are three things to consider.

1. The Headlines Were Totally Overblown

While factually correct — the Dow did indeed have its single biggest index point decline in history — it's sloppy for people to quote index point moves to non-business news viewers when they should be using percentage point moves.

Let's explain using Feb 5 as an example:

The Dow was off 1,175 index points, but the index started the day at a value just over 25,500. So in terms of percentage points, it was a 4.6% decline. That's not insignificant, but it's nowhere near the worst drop in history, when framed as a relative movement.

Joshua Brown, the CEO of Ritholtz Wealth Management in New York City, put it in great perspective on his blog. Based on his analysis, if you were to rank the worst single day percentage losses on the Dow in history, this decline doesn't even crack the Top 100.

Here's some more perspective on how big this drop was (or wasn't):

If we go back to Black Monday (Oct 19, 1987), the Dow dropped 508 points. In terms of index points, this is less than half of the 1,175 drop that made all the headlines. But because the index was only valued at 2,246 at the start of that trading day, this translated into a percentage point drop of 22.6%. That's almost five times worse in percentage terms while being less than half in terms of index points.

2. Most People Don't Have 100% Exposure to the Dow

Relatively few investors in Canada have their entire portfolio tracking the Dow. Instead, a properly constructed Canadian investor's portfolio is going to be balanced between stocks and bonds, with exposure to markets around the world.

There is usually a "home bias" as well, which means that while Canadian publicly traded stocks represent about 2-4% of the world's publicly traded stocks, Canadians tend to have a much higher representation of their stock exposure in Canadian stocks (partly because of familiarity and partly because of tax advantages).

This means many investors who hold a globally diversified, balanced portfolio didn't see their individual portfolio move to the downside by 4.6% just because the Dow did.

3. The Short Term is Unpredictable, but We Knew That

If you're investing for the long term, and have exposure to higher return potential investments like stocks, then you should know that the trade off is higher risk. That risk is synonymous with volatility when we're talking about broadly diversified investment funds and indexes. Let's put what happened into context of the past year, instead of just the past month.

Source: Yahoo Finance


Many have argued because the market had been doing so well without any hiccups, we were due for "something" to happen. The last few years have been marked by relatively little volatility given the good performance of markets. Some people have just forgotten what more normal market movements look like.

Source: Yahoo Finance


Even if we go back 10 years — which would then encompass the Great Financial Crisis that wreaked havoc on markets around the world — simply holding through thick and thin would have left you in a higher position today even if you bought right before the Great Financial Crisis hit.

Think of long-term investing as a person walking up a mountain with a yo-yo. If you focus on the short-term (the yo-yo constantly going up and down), you'll find it hard to sleep and you might end up doing damage to your returns. But take a step back and focus on the big picture and you'll see that while the short term is wildly unpredictable, the long term has followed a pretty standard playbook for decades: the short term can look like a yo-yo, but the long term looks like someone gradually climbing up a mountain.

So What Should You Do?

If you have a properly constructed portfolio matched to your goals, time horizon, and risk, you don't need to do anything. Let the plan do its job. It's designed to take into account that stuff like this happens.

Keep calm, and carry on.

 

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