Volatility: The Silver Lining Playbook – Part 2
This week I will share the first four of the top ten reasons that I believe we need to reframe our view on volatility. I call this my “volatility silver lining playbook.” I hope these points shed more light on what volatility actually is and that, while disconcerting, it can also be a positive. Last year certainly gave us plenty to bite our nails over, and even though it was a tumultuous ride, plenty of good came of it.
Let’s get started.
Volatility is a wake-up call
Volatility reminds us that there is no such thing as an easy dollar in the markets. Until March of 2020, we had been lulled into a “low volatility” coma, and we forgot that the markets can do other things besides make us money. We all know how that ended. Low volatility environments can create a false sense of security, and before you know it, you’re taking on too much risk, and your portfolio is out of balance.
Volatility provides feedback for companies.
We are a capitalism-driven society, which means companies are always attempting to create new approaches and strategies for making money. The free market considers these and decides the winners and losers. The whole time, markets are moving and could care less about the R&D departments of these corporations.
Not all ideas are good ideas, and this is when volatility can step in and be helpful by sending a clear message to companies. The pressure that volatility puts on the company’s stock price may cause them to focus on their best ideas, the ones that may benefit their investors the most in the long term.
Volatility evens the playing field
Mr. and Mrs. Investor often get lost in the frenzy of the stock market with all its high-frequency trading algorithms. These algorithms are actually tied to a stock’s past 100 days of performance, while investors typically take a longer view than that. Algorithms are reliant on numbers and trends in the market. Still, long-term investors, in this case, humans, can do research, have advisors, and can take advantage of subtle shifts and new information to make better investing decisions. When there is a period of volatility, it should call long-term investors to come out and be opportunistic.
Volatility creates churn
If you took a look at a long-term price chart of the S&P 500, you would see that short-term volatility has been in literally every single bull and bear market. To long-term investors like us, short-term volatility can seem like white noise from a 30,000-foot view. At the moment, though, things are very unpredictable, and fundamental shifts may be happening just under the surface of that volatility. Typically, people get scared and sell their most significant positions, often rotating out of the best-performing stocks. I think of this as a reset period. During these reset periods, short-term traders, who aren’t always the best thing for the markets, are easily wiped out.
Tune in next week to learn three more ways volatility can be a silver lining.
P.S. If you enjoyed what you've read here and found it beneficial, we encourage you to share it with your friends and family. I firmly believe that an educated investor is more confident, which leads to healthier finances and fewer sleepless nights.
Until next time...