In the past week, the S&P500 Index logged a total of 838 points (intra-day volatility), on its way to closing flat for the week. Between the highest high and the lowest low was about 240 points, or 4.4% of the closing price. All for nothing, one might say. However, volatility serves a purpose, and is essential to maintaining and growing a profitable investment portfolio over time.
Much of the “real” money (meaning the real big money) is actually speculative, rather than “buy and hold” investors’ portfolios. Individuals generally lack both the time and expertise to be involved in frequent stock trading, and most who try to “beat the market” underperform their own assets.
What does that mean? Over time, a stock, an index, a mutual fund, or an Exchange-Traded Fund (ETF) amasses a performance record. Over the same time period, many investors buy and sell shares in those investments, often frequently, and most of those traders do not match the performance of the asset itself. Chasing market returns most often produces abysmal results.
The reason for underperformance lies in a very human desire to perform better by taking periodic action, rather than just sitting back and waiting. This practice is called market timing, and while it can be exciting, it generally fails. This week illustrated why, far better than words can portray.
Using the Dow Jones Industrial Average (DJIA) as our example, this week’s action would dizzy any sane investor. Monday’s 1034-point drop instilled fear enough in investors to cause many to sell perfectly good assets. Conversely, Thursday’s 683-point gain elicited seller’s remorse, and many repurchased their sold assets. This is a formula for underperformance. It makes my head spin.
Professional traders have experience and tools to react better than ordinary retail investors. They move huge sums of money on a daily basis, and are not afraid to make important decisions. Many are institutional money managers, representing hundreds or even thousands of individual participants, allocating block trades among them. For a price, of course.
Also in the trading arena are stockbrokers, making trades for their customers, while generating commission income for themselves. All these big players add to the market volatility on which they (hope to) thrive.
For the right people and individual traders, volatility also can add excitement to their lives. For the rest of us, it is a necessary evil. We understand that long-term investing has ups and downs that must be accepted during the process. Not to say that nothing ever changes, as portfolios, like their owners, evolve over time.
During time periods similar to the week just passed, high volatility can affect our mental equilibrium. Would someone please pass the Dramamine®?
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