State College, PA – I learned aviation slang for turbulence is called dirty air. What has been going on in the market is like dirty air? Recently we have seen the wildest ride on the Dow Jones industrial average in 17 years. Dow Jones is a representation of how large companies are doing and we saw many extreme two day swings. This year, so far, the areas of the markets that are UP to date include: some Fixed Short-Term instruments, US Large companies, and Emerging Markets, while US Small companies and Developed International are DOWN.
A couple of things we can draw from market volatility:
One, it proves, what academics tout, the market has a 2/3rds bias. In 2011 it was down, the last two years, 2012 and 2013, have been up, and perhaps 2014 will finish as a down year. That’s, yet to be seen.
Two, it creates opportunities for those disciplined investors. Prudence dictates we sell high. Recent weeks are a dramatic example of why we rebalance portfolios religiously, taking advantage of the swings in the marketplace and putting dis-similar price movement to work for benefit. We sell what asset classes are up, down to a target, take the gain and then buy asset classes that are down, up to target. Doing this, the academics have proven, you are always buying low and selling high. Rebalancing is one of the three basic pillars of investing own equities, diversify, and rebalance. It’s weeks like the last couple, that we appreciate down the road, when you look at the balance of our accounts. You see, you don’t need to worry about the volatility of the market, and timing the ups and downs. That is if you own the entire market place, rebalance on a regular basis, and let the market do what it does.
When the market is rocky or in the red is the time we need to be most vigilant because when the market starts to be volatile is when the money demons start to creep up. The main reason for rebalancing is to manage your risk so that you keep the same standard deviation (risk or sleep factor) as when you first purchased your portfolio. We want returns, but we also want to manage the downside loss potential at any given time. The market is like going up a flight of stairs, playing with the yo-yo, it goes up-and-down, but it always reaches new highs historically.