Ups and Downs of the Stock Market: What’s the Impact on Your Investments?
Cathy Curtis
Tuesday, May 25: Just another day in the stock market: The DJIA (Dow Jones Industrial Average) was down over 200 points mid-day but finished down only 22.82. It bounced around a lot all day. This kind of volatility has gone on for a long time now.
by Cathy Curtis, Certified Financial Planner
The Dow started out on January l, 2010 at 10,428 went as high as 11,205 on April 26, 2010. The low point so far this year was reached on February 8th when the Dow ended at 9908. The 52 week range of the DJIA (May 2009 to May 2010) was 8057 to 11,309. Before that, the recession low was hit on March 9, 2009 at 6547 – level not seen since 1996. Are you dizzy yet?
The point of citing all these statistics is to illustrate that volatility isn’t unusual and isn’t going away.
The Dow…is made up of only 30 stocks and is not the perfect proxy for the stock market! But it’s the most widely recognized and you can be sure that the S&P 500 and the Nasdaq were jumping around too.
Simply Put…Stocks are Volatile
Volatility is a characteristic of stocks. (The volatitality of stocks is #9 on my list of 10 Simple Truths about Money!) Just like you have a gregarious personality or are shy, stocks have volatility.
Volatility measures the relative rate at which the price of a stock moves up or down. Usually the riskier the stock is perceived to be, the more volatile it is. However, this doesn’t imply that the riskier stock will end up losing value over time. This is where most investors get confused.
Volatility Does Not Imply Direction of a Stock or the Stock Market
The long term trend of the market is up. Compare investing in the stock market to raising a child. There can be emotional ups and downs over the years as the child grows up and matures.
Would you abandon your child because he throws a huge temper tantrum in the cereal aisle at Safeway? No. You will patiently get through that episode and many others like it because you know in the end you will have raised a loving child who will take care of you in your golden years.
The stock market behaves the same. It can drive you crazy with worry as it goes up one year 20% and down the next 10% and then back up 30%. But, if you hold on you will be rewarded by better returns on your money than you can get in less volatile assets such as bonds or CD’s.
Stock Volatility and the Impact on Retirement
But, you ask: What about people who are nearing retirement or who are in retirement and the stock market drops like it did in 2008?
Good question. Short-run volatility in the stock market can be a big problem for retirees and for other people who have near-term needs for their money. No one wants to sell a stock when it is down 30% (if it is a perfectly good stock). This problem is easily resolved: a good rule of thumb is that any money that you will need to spend within 3-5 years should probably not be invested in the stock market – especially if you are not earning any money.
Most experts don’t agree on what causes volatility to fluctuate or what causes it in the first place. When unexpected things happen, volatility seems to increase. Which doesn’t help us much because nobody can predict the unexpected. A quote from the book Against the Gods: The Remarkable Story of Risk, sums up the risk of volatility nicely:
“The real risk in holding a portfolio is that it might not provide its owner, either during the interim or at some terminal date or both, with the cash he requires for essential outlays” Robery Jeffery, investor.
Here are a few tips to help to increase your comfort level with volatility:
1. If you are retired or not earning income keep 3-5 years of cash needs in money market funds, Treasury Bills, CD’s or other short-term money market instruments.
2. If you are working, maintain an emergency fund of 3-6 months of living expenses.
3. If you are worried about losing your job, increase your cash nest-egg to at least one year of living expenses.
4. Maintain a diversified portfolio of stocks, bonds and cash depending on your risk tolerance and time horizon. (Not all asset classes go up and down at the same time, reducing volatility.)
5. Don’t just sit on your assets. Rebalance your portfolio occasionally to take advantage of volatility in an asset class: buy low, sell high.
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Category: Your Finances
About the Author (Author Profile)
Cathy Curtis is an independent fee-only Certified Financial Planner and CA Registered Investment Advisor based in the San Francisco Bay Area. Her firm, Curtis Financial Planning (since 2001) specializes in the finances of women, their families and their businesses.
Cathy passionately believes in Financial Literacy and educates consumers through her website CurtisFinancialPlanning, her blog: Of Independent Means, and her facebook business page Women and Money. She speaks frequently about personal finance issues – most recently at the Financial Women’s Association in San Francisco, National Association of Personal Financial Advisors Norcal Group, and the Commonwealth Club.
Check out Cathy’s Author Library to learn more practical and helpful tips on Money Managment!
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Great post, Cathy. Having three to five years of income in cash after retirement is an extremely prudent way to be able to tolerate the “tantrums” in the market.
The only thing that I would add is that even if you do not anticipate losing your job, having one year or so of expenses in cash is a wise strategy. Even those that do not anticipate losing their jobs sometimes lose their jobs! Or, many people want to start their own business and haven’t the capital to do it–having the cash account can allow people the flexibility to quit their job and start their business.
-Joe
Hi Joe, I agree with you! Thank you for adding your comments. Cathy Curtis