Understand Stock Market Volatility

Taking a longer view can also help put daily volatility in perspective. One way to measure return variability is standard deviation, a statistical measure that represents the degree of fluctuation in historical returns.

Over five-year time horizons, portfolios with more equity exposure in their asset allocation—the mix of stocks, bonds, cash and other securities in a portfolio—generally have a higher standard deviation (i.e., more risk) than portfolios invested more heavily in fixed income. Over 30-year time horizons, though, the standard deviation of equity-heavy portfolios decreases significantly—it is even lower than that of more “conservative” fixed income allocations.³

The Risk of Reacting to Market Volatility

Uncertainty is a given in investing, but that doesn’t make it any easier to “sit by” and watch your portfolio fluctuate—whether through minor day-to-day ups and downs or big negative swings. However, volatility today tells you nothing about how volatile markets will be tomorrow.

Trading at the wrong time or failing to stick with your long-term strategy can lead to significant opportunity costs over time—the difference in return between the choice you made versus the choice you could have made. If you attempt to sidestep regular negative volatility by jumping in and out of the market, you can face transaction costs and miss out on upswings.

Accidentally missing the best days in the market can cause cumulative returns over time to drop drastically. For example, over the 30-year period from 1988 through 2021, missing just the 10 best trading days would have cut your cumulative return by more than half.⁴

Volatility and Retirement Risks

Retirees often presume negative volatility is the biggest risk they face early in retirement. They assume negative volatility means each withdrawal they take is a higher percentage of their assets, increasing the risk they will run out of money. Each time the market experiences sustained volatility, personal finance websites pump out advice on how a new retiree should react to mitigate retirement risks.

Frequent suggestions include:

• Withdraw from the stock market and rely more heavily on Social Security or annuity payments for early retirement income
• Increase liquidity and carry a huge amount of cash
• Decrease equity exposure by moving more money into “low risk” asset classes
• Invest in target-date funds or another financial instrument that aims to dial back stock exposure over time

This type of advice is driven by the human tendency to feel losses more than twice as much as we appreciate gains, a behavioral finance concept known as myopic loss aversion. Myopic is just a fancy word for “nearsighted.”

This, combined with the belief that retirees should adopt a lower risk tolerance than younger investors, is presented as a positive approach. But far from protecting you from future losses, making drastic changes to your retirement plan can actually contribute to retirement risks for long-term investors.

Longevity Risk

Reacting to volatility early in retirement can also mean taking on longevity risk—the possibility that your actual lifespan will exceed expectancy projections. Nonagenarians (folks over 90) are the fastest-growing age demographic in America today. A 60-year-old American in good health can likely expect to live at least 20 years in retirement. Over that long span of time, volatility typically poses much less of a threat to investors.

The true threat to your retirement over these longer time periods is not earning enough money to fund your later years and failing to offset the impact of inflation or interest rates. Advice about how you “should” react to volatility ignores why retirees own stocks in the first place: compound growth. A positive return earned early in your retirement is vastly more important to your retirement plan than a return earned later.

While it may be difficult to endure volatility early in retirement, it is much worse to suffer late in life because you failed to earn a sufficient return from your investment. By reacting to volatility, you can run the risk of outliving your money or having difficulty covering day-to-day spending, healthcare or long-term care expenses.

Remaining Disciplined

Volatile markets are uncomfortable and can be even more so for a new retiree. But Fisher Investments believes early retirement is not the time to dial back equity exposure. A long-term investment strategy and a well-diversified portfolio are the best defenses against volatility.

Understanding how the market works is the first step in a good investment plan. As legendary investor Benjamin Graham put it, “The investor’s chief problem—and even his worst enemy—is likely to be himself.”

Volatility isn’t an enemy. It should never exclusively drive your investment decisions. Positive stock market returns are a result of volatility and are the reward for those who remain disciplined and focus on their long-term goals.

¹ Global Financial Data, as of 1/22/2021.

² Global Financial Data, as of 4/11/2024.

³ Global Financial Data, as of 11/10/2021.

⁴ FactSet, as of 2/15/2022.