Investors might as well get used to the market volatility. Whether you’re looking at stocks, bonds or commodities, asset prices have been swinging a lot more wildly this year.
The VIX, a measure of the stock market’s implied volatility based on option prices on the Chicago Board Options Exchange, has fallen from above 20 in January to the mid-teens, but bigger price moves across asset markets are rattling investors and challenging financial advisors to keep their clients committed to investing strategies.
“I don’t need to look at the VIX to see volatility,” said Barry Glassman, a certified financial planner and head of Glassman Wealth Services. “I talk to my clients, and I can see that volatility is back.”
Indeed, the major stock market indexes have had daily price swings of more than 1 percent far more often this year than last. Meanwhile, the yield on the 10-Year Treasury bond has risen by almost 75 basis points since bottoming at 1.64 percent in early February—its biggest sustained increase since mid-2013. Between the anxiety over coming interest-rate hikes by the Federal Reserve and more messy negotiations on Greece’s financial predicament, most advisors expect the volatility to continue.
“We’re in the sixth year of a bull market, valuations are at historic highs, and we have uncertainty about the economy and interest rates,” said Shannon Eusey, co-founder and president of Beacon Pointe Advisors. “I think we’ll continue to see a lot of volatility.”
So far, the stock market has recovered rapidly each time it has faltered in the last six months. Glassman said the uptick in volatility gives investors a chance to do some soul-searching.
“It’s a great opportunity for investors to assess the small dips we’ve had and consider how they would react to more volatility,” he said. “They need to know that a 10 percent correction in the Dow means an 1,800-point drop.
“If they’re uncomfortable with that, now is the time to scale back risk,” he added.
The volatility is also an opportunity for financial advisors to prove their worth to clients. Active managers, as a whole, have been killed by the major market indexes over the last several years. A good dose of volatility could give advisors managing diversified portfolios a chance to beat the indexes and to keep their clients from making emotional and often disastrous investment decisions.
“The average investor lags the market because they don’t have an investment process and they buy and sell things on impulse,” said Ron Carson, a certified financial planner and founder and CEO of Carson Wealth Management Group. “This is why people want advisors who’ve been through tough times and euphoric times and know the mistakes that investors can make.”
Carson doesn’t see volatility as a threat but as a chance to enable investment strategies to work.
“Volatility can help or hurt, depending on how you react to it,” he said. “It’s your friend if you have an investment process and you have confidence in your positions. It reallocates wealth from those who don’t have a process to those who do.”
“A client’s expected return has to align with their expectations about volatility so they don’t bail out on the strategy.”-Ron Carson, founder and CEO of Carson Wealth Management Group
Carson runs 14 different investment strategies for clients, depending on their financial goals and tolerance for risk. They range from most conservative, targeting a maximum portfolio loss of 7.5 percent, to most aggressive, for those willing to tolerate a 20 percent loss or more.
He spends a lot of time making sure the investment strategy matches up with a client’s goals and expectations of volatility. If they don’t, things go badly.
“A client’s expected return has to align with their expectations about volatility so they don’t bail out on the strategy,” Carson said. “It’s a big risk if the client isn’t prepared for the volatility.”
Eusey at Beacon Pointe Advisors also thinks the more volatile environment is a wake-up call for investors.
“This is the time to really review portfolios to make sure they’re well positioned to deal with volatility and that they can help you achieve your long-term goals,” she said.
Eusey expects active management to shine in a more volatile market.
“It gives us an opportunity to diversify a portfolio at a discount,” said Eusey, noting that a number of advisors at her firm have increased cash positions as stock valuations have risen. “We can buy beaten-up asset classes.”
The psyches of many investors are still scarred by the trauma of 2008, when stocks, bonds and other supposedly uncorrelated asset classes plummeted in unison. Few financial advisors see much risk of a similar scenario, but they acknowledge that many of their clients still worry about it.
“Could 2008 happen again? Absolutely. But I don’t think it will,” Eusey said.
Her bigger concern for clients is that as markets get volatile, they start making decisions based on their fears and emotions, not on their financial plans.
“The best thing we did for clients after 2008 was keep them invested,” she said. “No amount of insurance will protect people from themselves.”
—By Andrew Osterland, special to CNBC.com