As a fan of Vanguard and it's founder, John Bogle, I want to share their recent timely article on market volatility. And I also must add my caveat about rules of thumb and averages. Here's the link to their three "Rules", which I'll summarize and supplement below:
Rule #1- Recognize that volatility and periodic corrections are common in equity markets. You'd have to be Rip VanWinkle to not be aware of this rule. Most of us are painfully recognizant of the roller coaster ride. And I would add bond markets too because as we saw in 2009 they are no longer the safe hedge against equity risk. Hell, any market these days, whether it's real estate or precious metals, is volatile because of the craziness with which investors are chasing returns.
Rule #2- Tune out the noise and remove emotion from investing. I'm on board with this. The two most common- and destructive -investor motivators are (1)Fear and (2)Greed. A realistic, well conceived Cash Flow Plan should be primary. As an adviser who constantly seeks to understand what has happened and will happen in the markets, I'm weary of all the retroactive blather from my colleagues claiming to explain the past while failing to predict the future. So yes, tune out the noise.
But I also believe emotions must be taken into account. Life is more than a math problem. It is more than just getting as much as you can. It is more than a fancy pie chart. A good adviser will use a process to ferret out and give shape to clients' true feelings about their situation and the future and then build a plan accordingly. The goal should be to feel safer and happier!
Rule #3- Make volatility work for you. This rule appears to be directed at younger investors who have time to dollar cost average into the market. At least it had better be, because for the retiree drawing down assets, volatility is a retirement killer due to sequence of returns risk. To apply this rule to retirees it should be stated as "Keep volatility from destroying you". Here's the difference and how to avoid getting stung by volatility in both cases:
- Dollar cost averaging for Accumulators- By investing the same fixed amount every month, volatility becomes your buddy. When, for example, a fund costs $100/share this month and you are investing $500/mo. you'll buy 5 shares this month. But if the fund price drops to $50 next month, hurray! You buy 10 of the now cheaper shares. If the price then rises to $250 three months from now, you only buy 2 shares. So dollar cost averaging neutralizes the two destructive investor emotions, fear and greed, by making you act counter to your intuition: when shares increase you buy fewer, when they decrease you buy more. Dollar cost averaging alone can increase your returns 30% or more over the long term. But, there is . . .
- Sequence of Returns risk for Decumulators- On the other hand, if you are decumulating you need to adopt the opposite tactic. Instead of a fixed dollar amount you should withdraw only a fixed percentage of your total assets. That way when the market is down your withdrawals will be less, when it's up you can take out more or- better yet -leave more in the market for further growth. Why this is important: Imagine a 57% decline in your retirement account in the same year that you've also taken out 5% to meet your budget. To recover, you would need a 263% rate of return the following year! Which is impossible. This is why losses in the early years of retirement must be avoided, unless you have excess assets you can leave untouched for at least 10 years. Unnlike Vanguard's "inaction plan", in this case it is absolutely not "okay to ignore volatility".
Your Constructive Comments are Welcome!