Volatility: What to watch for and why
Joel Dresang: Kyle, I want to talk with you about stock market volatility. We usually hear about that when the stock market indexes are going down, but let’s clear that up. There’s more to it than just when stocks sell off, right?
Kyle Tetting: Absolutely, Joel. You know, volatility doesn’t strictly measure those down days in the market, but I think that tends to be what we hear about in the financial press. You string a couple of pretty significant declines together, and all of a sudden everybody’s shouting how volatile things are. But it’s important for investors to remember that volatility can be on the upside as well, that you can have big swings higher. You measure volatility all the same.
Joel: So, and how do measure volatility?
Kyle: So one of my preferred ways to look at volatility is to just simply count the 1% swings in a particular index. We used to be able to say you, you count a 100-point move in the Dow (Jones industrial average) as a day that’s pretty volatile. Yeah, 100 points was a big deal back when the Dow was at 10,000, but we’re a long way from there.
So, if we get back to that 1% – a nice round number to say here’s a day that’s a little bit more than just calm, you can start to count those up. You can start to put those 1% days together, compare those to history, compare those to some averages to get an idea of are we witnessing more 1% moves right now, this month, this quarter, this year, than we have in previous months, quarters or years.
Joel: And what do you learn from that?
Kyle: You know, Joel, I think it’s important to remember that what we’re measuring is what has happened, and so it tells investors a little bit about what markets are doing. But, of course, it doesn’t tell us direction. It doesn’t tell us if those things are up or down. And it doesn’t tell us much about what to expect going forward.
Joel: So what do you do about that – going forward?
Kyle: The Chicago Board of Options Exchange puts out the VIX or the Volatility Index. And that is a measure, a forward-looking measure of volatility. It tells us what volatility is going to look like over the next 30 days, or perhaps what it should look like over the next 30 days because nothing is a perfect predictor.
The challenge there is it’s a very complicated measure, and again it tells us nothing about direction. It tells us a lot about what we should expect, what investors think is going to happen with volatility, but very little about whether that’s going to be to the upside or to the down.
Joel: Why should investors care about volatility?
Kyle: You know, I think what volatility really brings to the forefront is investors who maybe aren’t properly allocated. It’s one thing for the markets themselves to bounce around, but if you also see your portfolio bouncing around more than you’re comfortable with, that probably points to an allocation that’s not correct or an allocation that isn’t tailored to your risk tolerance as an investor.
And the most important takeaway for investors is to just make sure that if they’re seeing volatility, is it volatility in their own portfolio or is it volatility in the markets?
Joel: And then, what can they do about volatility?
Kyle: You know, Joel, if it is volatility in their own portfolio and just not volatility more broadly, then the next question is have we gotten risk tolerance correct? Have we made that measure? Have we asked those questions of ourselves to make sure that we’re taking an appropriate level of risk?
And if the answer to that is no, that our portfolio is exhibiting more fluctuation than what we’re happy with, then we need to take some steps to really figure out what it is we should be putting in our portfolio. That often means introducing more diverse asset classes, bringing in bonds if you’re too heavy in stocks, bringing in non-U.S. stocks if you’re too focused in the U.S., to truly build a balanced portfolio.
Kyle Tetting is director of research and an investment advisor at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Peter May and Jason Scuglik
Volatility is back: 5 things to know, a Money Talk Video with Dave Sandstrom
Risk: How much can you stand? How much do you need? a Money Talk Video with Isabelle Wiemero
The ups and downs of volatility, a Money Talk Video with Steve Giles
Your one-minute guide to stock volatility, from the Financial Industry Regulatory Authority
(initially posted November 13, 2018)