Volatility and Emotions

Saying the first four months of 2020 have been volatile is an understatement. The day-to-day financial market swings can cause anxiety and fear. Add in the hourly business news cycle which often include a multitude of conflicting opinions can cause an individual investor’s head to spin – and we are only one third of the way through 2020. This situation can become emotional, perhaps overly emotional. Emotion and financial decisions are not an optimal combination. Some investors are quick to ‘sell everything’ or just give up and believe the markets are rigged. None of these actions have a high likelihood of success. 

Before committing to an investment decision, take a step back and examine a few aspects of your investable options. Large-cap stocks are just one. Additional investable assets are bonds, small-cap stocks and commodities, to name a few. Each alternative asset class should be on your investable asset “menu”. To evaluate your options, take a look at the percent of change from one period to another. The table below displays the return from the beginning of the year to end of April levels for a few asset classes. (Exchange traded funds (ETFs) are used as a proxy for the asset classes)

Percent of Change
Market Segment1/2/2020 to LowExtreme to 4/30/20201/2/2020 to 4/30/2020
S&P500 (IVV ETF Proxy Large Cap)-29.1%27.8%-9.4%
S&P 600 (IJR ETF Proxy Small Cap)-41.9%32.6%-23.0%
Fixed Income (AGG ETF U.S. Aggregate Bond Index)-4.8%10.2%4.8%
Oil (WTI) (USO ETF Proxy)-83.1%8.6%-81.7%
VIX Short Term (VXX ETF Proxy)402.7%-49.2%155.4%

A view of the data shows that each asset class, except for fixed income and volatility (VIX), are below beginning of year levels. The VIX is a measure of the volatility in the stock market (the so-called “fear gauge”). Between January 2 to the end of April, the VIX increased the most. This makes sense if one remembers the day-to-day change of the domestic stock market that transpired. Daily swings of up 2% to down 2% occurred often. Fixed income (bonds), government and corporate bonds, are a relatively safe asset class during periods of high volatility. Oil is the poster child, so far, for 2020. As demand cratered worldwide from the evolving COVID-19 virus and OPEC+ push to increase supply, the price of oil fell precipitously day after day. 

The last two, S&P 500 and S&P 600, illustrates the difference that can occur between domestic stocks with differing market capitalizations. The small-cap IJR has fallen the most, a loss of over twice that of the large-cap IVV. 

For many individual investors the initial reaction when volatility is high is commonly to “sell everything”. That is a visceral emotional response. “Sell everything” is an easy decision. The next decision of when to buy back in is a much more difficult question to answer. Inaction and holding only cash are easy. But, does sitting out match with your personal risk/reward profile?