COLUMNS & FEATURES–Learning to Live With Market Volatility Can Pay Off

0

Repeat after me: “Market volatility is good. Market volatility is good.”

Say it until you believe it. You might as well, if you mean to be a long-term mutual fund investor who actually sticks around for the long term.

What’s the alternative? There doesn’t seem to be any good way to invest in stocks for growth if you’re not ready to withstand shocks zigs and zags that happen faster than ever, or at least feel as though they do.

Fortunately, there can be some honest-to-goodness benefits for long-term investors from dizzying short-term market swings. So our “volatility is good” incantation can be backed up by logic.

“This year’s volatility is unprecedented,” says Steve Leuthold, chairman of the Leuthold Group, a Minneapolis investment research firm. “The public’s stock market confidence has been knocked down a few levels.”

By Leuthold’s count, almost half the trading days in the first quarter of 2000 (48 percent) saw daily changes of 1 percent or more in the Standard & Poor’s 500 Index. That’s almost 2.5 times the median for the past 100 years.

The Nasdaq Composite Index rose or fell at least 1 percent almost three-quarters (73 percent) of the time. That’s more than four times the median of 17 percent over the index’s 29-year history.

So how can this be good, you ask, unless maybe you own shares of Smithkline Beecham Plc, maker of Tums, or Warner-Lambert Co., which produces Rolaids? First of all, it’s a plus to whatever extent it shakes up complacency, causing people to look clearly at risk, to reconsider their use of margin borrowing to finance investments.

“The appetite among investors to assume maximum risk in the pursuit of maximum reward will probably cool,” said Richard Hoey, chief investment strategist at Dreyfus Corp., which manages a $120 billion fund group.

These days also make clear the benefits of diversification as no words can do. “One has to be aware that fear and greed often overcome the most resolute intentions,” says Peter Moran, an investor at Saugatuck Trading LLC in Connecticut. “If you diversify, you lower your volatility.”

Provided that you do hang in there, interim volatility can work to your mathematical advantage when you follow a program of regular investments toward a long-term goal.

Suppose you invest $10,000 a year in each of two funds, the Placid Fund and the Frantic Fund, which behave differently as the market rises and falls. Over a three-year period, you buy Placid shares at $10, $9 and $11, and Frantic shares at $10, $8 and $12. Subsequently, the net asset value of both funds rises to $20. To keep the illustration simple, the funds make no distributions.

When you check your statements, you find you own 3,020.2 shares of Placid, worth $60,404, and 3,083.33 shares of Frantic, worth $61,666.60.

Let’s take this up a notch. If Frantic had swung down to $5 and up to $15, you’d now own 3,666.67 shares worth $73,333.40.

By this reasoning, regular investors get the most bang for their bucks from an investment that trades near zero all through the accumulation period, then soars just before they want to cash in.

Of course, you rarely find such an extreme case. When something like that does occur, hardly anybody has the skill and courage to capitalize on it. With good reason: If the investment doesn’t blossom at the end, all you’ve accomplished is to throw good money after bad, burning up a lot of precious time besides.

On a more modest scale, though, the benefit of volatility can be quite real. When the next storm hits the markets, hold that thought.

Chet Currier is a columnist for Bloomberg News.

No posts to display