Volatility Up…Hold On

Being able to hold on to your investments over the next several years will be an important strategy.

Friday was a hard day in the stock market with the S&P 500 down more than 3%. I would not necessarily say that August 21st was the “official start” of any particular phenomenon, but I do believe volatility in the stock market, and for that matter virtually all capital markets, will increase and remain high for many years.

Doesn’t everyone say that?

Yes, almost all investment professionals say that volatility will be a “factor” in the markets. It is something they can say and sound smart while not having to go out on a limb and make a particular prediction.

That said, I am specifically expecting volatility to be much higher for the next 10 years than it was, on average, over the last 25 years.

Demographics, winners and challenges

The reason for the increased volatility? Large numbers of baby boomers (and the pensions that will be paying them) will begin to spend down their investments in retirement rather than putting money in savings. This can exacerbate volatility. Conversely, higher additional savings (like the baby boomers were doing for the last 25 years) can smooth out volatility.

The hardest hit by the increased volatility will be:

1) Those who are spending down their investments – especially those who don’t do it in a smart manner. If they sell investments at the wrong time – when the market is in a sharp downturn – they may not be able to recover during the next upswing.

2) Those who have equity indexed insurance policies. This is a complicated subject. I wrote about it here and here. In short, these policies are hard hit when volatility goes up and dividends become a larger part of the market’s return, which is another phenomenon I expect to happen.

Those who will be helped:

Investors who are actually putting more money into their investments. The increased volatility can work in their favor, giving them some great opportunities to dollar cost average into their portfolios. It will be a hard ride, but many years down the road they will be glad they did.

Also, an investor who just holds on to their investments will be have a lot of protection from the volatility. The sharp ups and downs are most damaging when someone is forced to sell.