Carl Richards

During the last few weeks, I’ve heard a lot of chatter about volatility. I knew something was going on when I overheard people at the grocery store talking about their investments, saying things like,”This volatility is killing me.”

I used to joke that volatility was a word that people in the investment industry used and the rest of us nodded our heads at in agreement, pretending to know what it meant. Volatility has long been used as a proxy for risk, but in all the conversations I’ve had over the years, no one has admitted to laying awake at night over concern about their volatility.

Volatility is a measure of the variation of the price of an investment over time, but over the years I’ve referred to volatility as the amount something wiggles. Stocks wiggle more than bonds. Bonds (intermediate term bonds) wiggle more than cash. And, of course, cash wiggles the least of all.

So if you believe that risk and return are related, then volatility represents the risk of investing in a diversified basket of stock-based mutual funds and in turn it is the reason we get paid more to own stocks over the long haul than we do sitting in bonds or cash.

In the last few weeks, we’ve lived through a historic seesaw, including a period when the S.P. 500 either rose or fell over 4 percent for each of four consecutive days. While these dramatic days have us all talking, it’s important to realize that volatility and investing go hand in hand. They always have, and chances are they always will.

So if you’ve discovered that you can’t stomach the wild swings, now might be a good time take note of how much you didn’t like it so that when the time is right you can reduce your exposure to the stock market and add more bonds. The entire idea behind including bonds and cash in a longer-term investment portfolio is to smooth out the ride a little. Bonds act as ballast to the portfolio so that the swings aren’t as dramatic.

Please note that I’m not saying you should sell or buy stocks now. That is a entirely different discussion. I am just trying to point out the role volatility plays in an investment plan and one of the ways of dealing with it.

No one really knows if this type of volatility is here to say, but in the end it really doesn’t matter much. After all, volatility has always been part of the deal when you invest in the stock market. If you still believe that stocks will be a better investment over time than bonds, then you will simply have to deal with the volatility.

Article source: http://feeds.nytimes.com/click.phdo?i=8afb2c94edb8db6485e0a4fa5e470436