Markets haven’t been unusually volatile lately, but it can sure seem that way.
One way to gauge market volatility is with the Cboe Volatility Index, dubbed the VIX. If the VIX is at low levels, that indicates low short-term volatility in the S&P 500. If levels are rising, that corresponds with higher volatility.
Right now, the VIX is at its lowest levels since February 2020, before the pandemic was declared and lockdowns began. Those low levels indicate markets are trending along in an orderly fashion, without big upside or downside surprises.
So what is volatility, exactly, beyond a hunch or gut instinct that stocks are being whipsawed?
In its most basic terms, volatility is the rate of a stock’s price movements in either direction.
Here’s where it can get tricky: In the short run, stocks not only seem more volatile, but they really are!
Over time the average volatility of the S&P 500 is around 15%. But that level typically bounces around between 10% and 20%, although it’s not unusual to see spikes, as the chart below illustrates.
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This shows the Cboe Volatility Index on a weekly basis, going back to 2013. The spikes stand out during volatile times, such as the 85.47 level in March 2020. The VIX is often called “the fear index,” as it tends to spike when markets turn fearful about the near future.
So how do you use all this in your own investing?
First, it’s helpful to have a good understanding of exactly where markets stand, rather than guessing based on a scary news report. You’ll often hear or read market reports about sharp down days in the major indexes. However, keep in mind that one down day is not a trend. Even when markets trade lower for several sessions, that doesn’t mean we’re headed for a meltdown.
For example, markets wobbled twice in October and November 2020, ahead of the U.S. presidential election. Such wobbles are due to uncertainty. In this case, the reason for uncertainty was obvious. Keep in mind: Markets generally don’t care which party occupies the White House; investors simply want to know who will be at the helm.
As soon as investors had some confidence about the election results, you saw markets begin a decisive uptick.
Over time, volatility smooths out, but that doesn’t mean it’s easy to sit through it, when you’re watching your account value decrease, and financial TV channels are encouraging you to panic about market movements.
Even if you can remain calm and rational during big pullbacks, it’s tough to focus on the long term. That’s why investing for retirement is so difficult. It’s hard to keep your eye on the future, when things look rocky today.
Twenty-first century investors have not only the pandemic pullback of February and March 2020 on their minds, but also the financial crisis of 2008. It’s terrifying to think of the damage a big pullback can do to your nest egg, especially if you have retirement in your sights.
I understand the temptation to view your accounts on a daily basis, just to check and be sure you haven’t lost your shirt.
Despite normal short-term volatility, markets do eventually settle down and trend higher. Who expected the swift decline in 2020 would reverse upward, with stocks rising to new highs by August, finishing the year at record levels?
I understand tactical investing, and the desire to swap out one security for another as asset classes rotate in and out of leadership. That’s OK if that’s the path you choose, but be cautious that you have a plan to allocate properly, rather than just panic-selling when you see market volatility.