Market Volatility, much like the sequence of returns risk, can ruin your hard work and savings if not properly defended against. For instance, as a whole, CSI Market reports technology has seen over 31% growth in value in 2020, whereas the energy sector has seen a 21% contraction of value in 2020. Thus, reviewing the S&P 500 or Dow Jones Industrial Average as the sole indicator of performance would be a significant disservice to investors. Diversification of assets, both in regard to the type of security (equities, bonds, or derivatives), sector (real estate, healthcare, technology, etc.), and Investment Time Horizon, is always essential in maintaining steady and consistent growth in wealth management.
Market Volatility Tolerance
Although eliminating volatility altogether is optimal, “risky investments” are considered risky for their underlying volatility itself. Minimizing risk to the level of near absence provides your capital little to no opportunity for growth. Further, the idea of outright elimination of volatility is not achievable as the market and investments rely on the level of “risk” of volatility themselves. In general, the level of volatility should coincide with the opportunity for growth. For instance, a US 12 month “T-Bill” is seen as the safest asset in the market, however, its return in 2020 is a dismal 0.12% annualized yield. Inflation, as we’ve discussed in another article, would greatly outpace your capital’s buying power with inflation often surpassing 2% each year.
Because volatility and risk is unavoidable it is best to control and plan with risk in mind, and ensure that growth and opportunity succeeds the underlying risks. As a matter of fact volatility and risk can be mitigated with time, just like the many individuals that have withstood the 2000 “dot com” bubble, and 2008 recession that cost many investors as much as 50% or more of their capital. Nonetheless, the bull market, since 2008 lows, have returned in excess of 500% from S&P500 market lows of $676 to the all time highs of nearly $3,700 the S&P 500 reached in late 2020.
Although 500% return is astonishing for a broad based index, over the span of 12 years, just like the sequence of returns risk, it is only if you are able to stay consistently invested for this amount of time. For those nearing retirement this is simply unachievable, thus this is the importance of understanding each individual’s market volatility tolerance.
KCA Wealth Management has a “Riskalyze” calculator, which is technology we offer our clients to help them understand their exposure. This tool, in collaboration with many others, and the theory of books and strategies such as “The Bucket Plan” are essential to ensuring you mitigate risk in the near-term. This enables one to invest capital not needed in the foreseeable future, to riskier and volatile investments that provide your portfolio and overall wealth the greatest opportunity for growth.
Investment Time Horizon
In fact, in “The Bucket Plan”, volatility and time horizon risks are minimized by establishing the three phases, or “buckets”: the immediate (Now), the short term (Soon), and the long term (Later). This provides you the opportunity to access the money you need now, by conservatively investing the short-term money you may need in the coming years. Lastly, your later, or soon, bucket enables you to invest more aggressively for growth with investments that have little to no time horizon risks. You can find more and a video here from KCA Wealth Management on bucket plans. If you’d like a copy of the book please fill out the contact information on the landing page of the video.
Investment Time Horizon, according to Investopedia, is the period of time one expects to hold an investment until they need their money back. For example saving for retirement is a long-term goal from the beginning of your “accumulation” or working years. However, saving for shorter-term goals, such as buying a home or saving for a loved one’s education, requires more careful management, as the desired withdrawal date is nearer term.
Because of these varying goals for shorter-term goals it is essential to diversify your asset classes to ensure you do not lose capital prior to your financial obligation to meet your goals. According to Zacks investing in the general stock market, such as the S&P 500, average return comes to 10% over the past 100 years, whereas bonds return just 5-6%. However, bonds, if held long-term, represent fixed growth. This fixed growth can provide certainty and security of ensuring you can grow your assets in anticipation of a nearer term goal.
At KCA Wealth Management our mission is to be there every step of the way in supporting the members of our community with the financial and educational resources they need and deserve to prosper in retirement. Ensuring adequate diversification, while considering your investment time horizon, is essential in ensuring your hard work and savings result in a prosperous retirement exceeding goals.
Diversification and asset allocation strategies do not assure profit or protect against loss. Past performance is no guarantee of future results. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal.