Volatility and risk are two different things

When the stock market gets rocky, a lot of people instinctively pull back. They see prices bouncing up and down and assume that volatility and risk are the same thing.

I don’t see it that way.

To me, risk is not simply the possibility that your investments might lose value from time to time. I think risk really means the chance you won’t achieve your financial goals. It’s the failure of building enough wealth to retire comfortably, or that once you are retired, it’s watching your lifestyle slowly erode because your money can’t keep up with inflation.

That is a very different definition of risk, and it leads to a very different way of thinking about investing.

Yes, stocks are volatile. They always have been, and they probably always will be. Prices can swing sharply in the short run, sometimes for reasons that make little sense at the time. But volatility by itself is not what causes lasting harm. It only becomes damaging when investors react to it the wrong way.

For most people, there are two ways that can happen. The first is when you choose to sell investments out of fear when prices fall. The second is being forced to sell them at the wrong time because you need the money.

That distinction matters.

For someone who is still working and saving for retirement, market volatility can potentially be a gift. If you are investing steadily into a 401(k) or other retirement account, a declining market allows you to buy more shares with each contribution. When prices are lower, your money buys more. When prices are higher, it buys less. Over time, that simple discipline can work powerfully in your favor.

That’s the beauty of dollar-cost averaging. It is not flashy, and it is certainly not exciting. But it gives long-term investors a systematic way to accumulate assets without trying to guess when to buy or when to sell. In fact, one of the great ironies of investing is that a bear market can be one of the best things that can happen to disciplined savers. Lower prices today can mean greater wealth later on.

Retirement, however, changes the equation.

When you are no longer building wealth but trying to make it last, volatility has to be handled differently. If you are selling investments regularly to create income, a down market can do real damage. Why? Because when prices fall, you must sell more shares to generate the same amount of cash. That can permanently impair a portfolio, especially early in retirement.

This is why I believe retirees need a different framework.

Rather than relying entirely on a portfolio liquidation strategy – the vaunted “four-percent rule” comes to mind – we design and manage portfolios based on when each dollar is meant to be withdrawn and spent. Money earmarked for short-term spending needs, such as withdrawals you plan to make over the next five to ten years, is invested in predictable, stable, fixed-income vehicles. We call this the “Reserve” portion of the portfolio.

Will the Reserve earn less over time than equities? Most likely. But that’s not the point. Its job is not to maximize growth but to help provide stability and spending power so that you’re never forced to sell stocks in a bad market just to pay the bills.

I’ve said this a thousand times: stocks are no place for the rent money.

By contrast, the Equity portion of a retiree’s portfolio should be positioned for longer-term growth and income, with enough time to recover from bear markets. In many cases, that includes owning shares of quality companies that not only have appreciation potential but also pay dividends and have a history of increasing those dividends over time.

The bottom line is simple. Volatility is not the same as risk. Risk is when you don’t reach your goals; volatility is mostly background noise. For investors still saving, volatility can be a potential advantage when paired with discipline. And for retirees, volatility becomes far less threatening when short-term spending needs are kept out of stocks and the day-to-day uncertainty inherent in owning them.

So here is the question worth asking: Is your portfolio built to survive volatility – perhaps even benefit from it – or are you still treating volatility itself as the enemy?

That one distinction can make all the difference.

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The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Mike Brown and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Past performance does not guarantee future results. Future investment performance cannot be guaranteed, investment yields will fluctuate with market conditions. Investing in stocks always involves risk, including the possibility of losing one's entire investment.

Dollar-cost averaging cannot guarantee a profit or protect against a loss, and you should consider your financial ability to continue purchases through periods of low price levels.