Has anyone noticed that equity markets seem to be more volatile? In the investment business, we talk about volatility as the moving up or down of a stock price and index.
Some investors associate volatility with loss of value. We look at it as risk.
Anyone ever get a statement from their adviser and the value is down?
How about at the end of June this year? (In June of this year, the markets reacted to Ben Bernanke of the U.S. Federal Reserve and his use of the term “taper” with regard to the bank’s buying of government bonds and MBS).
Volatility has definitely been more predominant over the past 10 years. The markets are reacting to just about everything lately and they are reacting stronger.
Volatility is when something you own goes up and down over time.
Let’s say you invest in $10,000 of XYZ Holding and it goes down by 10 per cent.
Doesn’t sound like much, but the next time you see your account balance has fallen to $9,000 from $10,000, have you lost money? Many people would say yes.
It is worth less and if I had to sell I would only get $9,000. But here is the rub. You should not be invested in XYZ if you need the money in the short run, so the short-term movement should not be relevant.
As advisers, we definitely don’t like volatility, but we are much more concerned with true risk. The risk of actually losing capital that will not be recaptured.
Investing in something and having its value fall and stay there is true risk. So if we are focused on true risk, why is there so much volatility in the markets of late?
Firstly, the participants have changed. What used to be made up of brokers and long-term institutions (pension funds, insurance companies and so on) now includes day traders, high-frequency traders, alternative strategy managers and high volume proprietary (prop) traders. These participants most often look for volatility to make gains on short-term trading. This definitely adds to market volatility.
Secondly, there is a little discussed accounting policy called “mark to market.” Simply put, this policy makes companies holding investment positions report, in their financial statements, what a position is worth today versus what they paid for it (book value).
When positions go down in value it is reported on paper.
This was designed to create more transparency, which it does, but this system also forces the long-term holders of these positions (institutions such as pension funds and insurance companies) to react, and possibly sell, in the short run as they have to report the change in value.
I sit on the board of a long-term investment entity (a foundation) and we have had to adapt to the shorter reporting horizon and adjust our portfolios accordingly to avoid this volatility, so I can see this change first-hand.
Invest in sound enterprises that you understand and hold them for the long term, training yourself to ignore the short-term noise. That’s still my best advice.
Les Consenheim is a financial adviser with Raymond James - Consenheim and can be reached at 250-372-8117 or email@example.com. Raymond James Ltd. is a member of the Canadian Investor Protection Fund. This article is for general information purposes only. The views of the author do not necessarily reflect those of Raymond James. Individuals should seek professional advice prior to acting on any information referred to herein.