Swedroe: Riding Out The Volatility

August 31, 2015

Since the middle of August 2015, market volatility has escalated. As is usually the case when volatility spikes, global equity markets have experienced substantial losses. While there are no doubt a multitude of contributing factors (as discussed in my blog post on Aug. 26, 2015), some of the most obvious are the slowdown in the Chinese economy—the world’s second largest—and the sharp pullback in its stock market, along with the collapse of the prices of industrial- and energy-related commodities.

Given the current downturn and increase in stock market volatility, many investors are concerned and wondering whether now is the time to rethink their portfolios. While investors should always make sure their appetite for risk matches the risk embedded in their investment portfolios, market movements alone are not a good reason to alter investment plans.

Stock markets have always been, and will always be, risky. Their inherent riskiness is, in fact, the reason stocks have provided higher returns than safe bonds.

Putting Market Volatility In Context

While recent stock market volatility has been high, markets have experienced periods of higher volatility in the recent past. My colleague and co-author Jared Kizer put together some charts that show the historical evidence on volatility. Figure 1 below shows the historical values of the VIX Index, the market’s “fear gauge,” over periods going back to 2007.

Historically, the volatility of the stock market has averaged about 20 percent per year. More recently, the market’s expectation for volatility has exceeded 40 percent. So volatility has certainly increased beyond its more “normal” levels.

However, Figure 1 shows that market volatility was at similar (and in some cases higher) levels for virtually all of 2008 and 2009, and even as recently as mid-2011. In fact, while you cannot see it on this chart, the VIX exceeded 80 on both Oct. 27 and Nov. 20 of 2008.

While recent volatility is certainly discomforting, investors should be aware that markets have gone through similar, and even more extreme, episodes of volatility in the not-too-distant past.

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