Ferri: Dealing With Volatility The Right Way

Doing nothing as markets turn volatile may be hard, but it's the right thing to do.

Volatility. Investors hate it. Any downturn in stocks creates fear for even the most experienced investor. We can’t get around it. The feeling is natural. When something is cutting away at our net worth, we want to stop it. “It would be nice to have my money in cash right now,” our minds tell us, even though we know that’s not in our best long-term interest.

How do we deal with this?

The most common remedy to all stock market volatility is to tell ourselves to ignore it. “Let it be,” as the Beatles would say. “This too shall pass,” as the old saying goes. “Stocks will recover,” we tell ourselves, “it’s just a matter of time.”

Ignoring volatility can work, but it’s like ignoring an earthquake. The landscape is shifting before our eyes and the future is suddenly unknown. Feeling the ground rumble in an earthquake is alarming no matter how many times we’ve felt it before. The natural tendency is to be afraid. And the longer it goes on, the more intense, the greater our fear.

Unfortunately, there is not much we can do about an earthquake. It’s not as though we can leave the area or elevate ourselves above the mayhem. We endure it until the tremors stop. That’s not true about market volatility. You have a choice to stay or leave.

Here’s the problem. Leaving the stock market in the middle of volatility is generally a bad idea because it’s done out of fear. People make the biggest investment mistakes when they’re fearful. It’s even more powerful than greed.

Nobel laureate Daniel Kahneman believes the response to a price drop elicits a stronger emotion than a response to an equal price gain. Some people fear loss twice as much as they relish success. This makes fear a powerful enemy of an otherwise level-headed investor.

If you feel the urge to exit the market during a volatile period, you would do well to remember that you picked your equity allocation willingly and likely during a period when you weren’t emotional. No one forced you to pick this spot on the risk-and-return curve. You did it in good conscience and for good reason. The trick is to recognize Kahneman’s observation that the fear of loss is more powerful than the joy of a gain, and that you’re experiencing that now.

You may be saying, “Rick seems pretty confident the market will recover. What if this time it’s different?” If you believe the stock market may not come back this time, then you have much more to worry about than your investment portfolio.

The U.S. is the leading capitalist economy in the world. If companies don’t make money in the long run, the entire global economic system would collapse.

The answer to stock market volatility is to let it happen. Complain about it if you wish, scream about it if it makes you feel better, but don’t do anything about it. Yes, it’s a painful solution. But it’s the right solution. The stock market will recover and move higher. It always does.

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