The Definition of Volatility

Feb 4, 2014Intentional Ownership

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January was a very volatile month. The market was down over 3%. If we look at yesterday, the first trading day in February, that trend continued. The market was down over 2%, but this time everyone is nervous about the word volatility. I thought it was a good chance just to take a step back and ask the question why?

Did you realize that 2013 was a very volatile year? Don’t believe me? Well, ask yourself this question…. If the markets had dropped 20% over the last year, instead of rising over 20% would you feel like the last year was volatile? You probably would.

To make sure we understand the word volatility, I thought we’d pull out the dictionary. When we look, what we find is volatility is an adjective, and when it’s speaking of prices and values it means “tending to fluctuate sharply and regularly”; sounds a lot like 2013. You will notice this definition doesn’t tie you to the direction of the fluctuation and whether it was up or down.

Look back at the beginning of 2012. The S&P 500 was at 1402. Yesterday it closed at 1743; that’s about the same level it was three months ago. People back in November were pretty happy with where they sat at that time. The S&P 500 has averaged to drop 15% every year since 1980 when the index began. At the beginning of 1980, the index was at 106. Today it’s at 1743. That’s an average return of 10% a year with dividends reinvested. But look back at the calendar of those years and you will find a lot of volatility along the way.

There’s a lot of research that has shown behavior as one of the biggest drivers of individual investor performance. Meaning it’s an almost certainty that people who react emotionally to volatility, either through euphoria or through panic, end up with less than favorable investment results. Our primary objective is to help you keep the longer term in perspective and ignore the distractions that come along the way. I know that we can’t control volatility, but what we can control how we react to that.

Thanks for being with us. We’ll see you again next time.