On Volatility

September 16, 2015

Market volatility is on the rise following a number of years of relative tranquility. It is times like these in which a laser focus on long-term fundamentals and diversification, as opposed to short-term news, will allow for increased risk adjusted returns.

European crises, China concerns, central bank policies, and geopolitical conflicts are a few of the topics causing concern today. As a result, overreactions to short-term news and regular market movements are leading to questionable investment decisions. That being said, one investors sale is another’s purchase and there are deals to be had. Instead of fearing volatile markets, we remain committed to concentrating on long-term economics and company fundamentals.

There is presently no clear approaching end to the stock market volatility, especially as valuation levels increase and the Federal Reserve is increasingly likely to raise rates. As a result, the investment time horizon emerges as a key element effecting the success of fundamentals and portfolio diversification. Although historical performance is not an indication of future returns, the following graph shows the financial impact of time horizon on investment returns from 1950 through 2014 and its ability to mute the impact of volatility:

The main take away here is that the highly variable returns experienced on a day to day basis are heavily muffled over the course of months and years. Therefore, expanding an investors holding period over years and decades has historically improved the risk/return profile of a portfolio. In fact, the worst 5-year period since 1950 experienced a 2% decline, and yet there was not one 20-year period that experienced a loss.

It is critically important to keep volatility in perspective. Investing over the long-term in a diversified portfolio of high quality companies serves to maximize risk adjusted returns.