Insights: Article

Some Volatility – Finally!

By Paul Junek

March 28, 2018

Between Jan. 26 and Feb. 8 of this year, the Dow Jones Industrial Average dropped 2,757 points and the media totally freaked out. Ironically, most of my clients didn’t. I credit this to having a savvy client base that enjoyed the ride up, but with an often repeated mantra of “I know it can’t last forever.” Now that the markets have gained back much of what they lost during those crazy two weeks, we can step back and review what happened and how to prepare for the next one.

Interpreting the News
Two things about watching the market on the news: (1) the Dow Jones Industrial Average (DJIA) isn’t the best summary of the broad stock market and (2) looking at the number of points, rather than the percentage, is a good way to grab headlines (remember when it dropped a thousand points in a single day?!).1 Let’s instead be the sophisticated investment advisor and look at the S&P 500 which only dropped 10.2 percent over the same time period, versus 10.4 percent for the DJIA.2

That 10 percent number is key as it defines the other term you likely heard in the news; “correction.” The correction technically happens when the market breaks through that 10 percent decline threshold, in this case occurring on Feb. 8, 2018. Although 10 percent appears to have been selected because it was a nice, round number, hitting that magical correction number was significant—the market rebounded more than 5 percent over the following five days of trading. In this case, it appears that many investors had been sitting on the sidelines waiting for an opportunity to “buy cheap” and jumped in when the correction point was hit.

Should I Make a Change?
As of this writing (March 27, 2018), the S&P 500 is currently up for the year. This comes as a surprise to most friends and clients I speak with as the “Correction” got huge media coverage. The rebound from the bottom was just back to business as usual and was therefore not nearly as newsworthy. Therefore, the answer is simple: no, you shouldn’t make any changes to your portfolio based solely on what the S&P 500 has done in 2018.

However, I encourage everyone—clients, friends, family—to take a look at how they’re currently invested to make sure it still meets their risk profile.

Take for example a client who invested $100,000 five years ago at 70 percent stocks and 30 percent bonds. Let’s assume in those five years that the stock portion of their portfolio has returned an average of 10 percent per year and the bond portion has returned 3 percent. Where would they be now? Keeping this simple, we’ll ignore interest, dividends, taxes, etc.:

Year 1 Year 5
Stocks: $70,000 (70%) $115,171 (77%)
Bonds: $30,000 (30%) $34,849 (23%)

 

Without making any changes to their portfolio, this hypothetical investor is now significantly more invested in stocks than they’d initially intended. As a result, a correction in the stock market would have a bigger impact on their account today than it would have five years ago.

The solution is called rebalancing – periodically bringing a portfolio back into the range of the original risk profile. Some investments do this automatically. It’s worth knowing whether yours do.

PerspectiveA Reminder
Lastly, I often find myself reminding clients of their time horizon. Even if you’re already retired, you may have a significant portion of your retirement funds that aren’t intended to be touched for years, if not decades. The history of the stock market, which is definitely not an indicator of future performance, shows us the last 7 years has been one of the greatest times to invest ever, but also that corrections, bull markets, and bear markets are bound to happen again.

Did the correction in February freak you out? If so, that’s still okay. Perhaps your tolerance for this kind of volatility has changed either because you’re getting closer to retirement, or your finances have changed such that what the stock market is doing matters a lot more to you today than it did many years ago. The reverse may be true, too—you may have cared less than expected after the perspective gained from a long ride up in your account value and perhaps earnings. Either way, your reaction to the news of the correction may indicate what your baseline risk tolerance, and therefore target stock/bond mix should be.

Need help reviewing your investments or determining what your appropriate mix of stocks and bonds? Your Eide Bailly tax advisor can work with you and a member of our Financial Services team to get you the specialized investment answers you need.

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Financial Advisor offers Investment Advisory Services through Eide Bailly Advisors LLC, a Registered Investment Advisor. Securities offered through United Planners Financial Services, Member of FINRA and SIPC. Eide Bailly Financial Services, LLC is the holding company for Eide Bailly Advisors, LLC. Eide Bailly Financial Services and its subsidiaries are not affiliated with United Planners.


[1] See Adam Davidson’s article in the New York Times Magazine titled Why Do We Still Care About the Dow for a good summary of why most investment advisors ignore the DJIA. Published Feb 8, 2012.

[2] I stick with my guns, the DJIA still isn’t great, though the S&P 500 has its flaws as well.

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