Learning How to Manage Volatile Markets

With the U.S. and world markets experiencing rather dramatic ups and downs in recent months, I’ve been getting more than the usual number of inquiries from clients who want to know how best to weather the predicted storm. “Given the state of the Stock Market, should those of us with much of our money there, just sit tight, or do something ‘more safe’ in the very near future?”

I consult my crystal ball, but it is opaque as always. As I frequently remind anyone who asks, I believe that neither I nor anyone else can reliably predict what will happen with the economy or markets in the short term. If only they would add clairvoyance to the list of required courses at CFP® school!

Important to be Positioned for Long Term

Instead, all the financial advice I give is based on the knowledge of how markets tend to behave over the long term (and why), in conjunction with a heavy dose of time-tested principles about spending less than you earn, saving for a rainy (or snowy) day, and managing risk. Unfortunately, none of this comes with guarantees. “Managing risk” is not the same as eliminating it. And while it’s probably harder to remember in conditions like these, we wouldn’t really want to eliminate risk. Why? Because it is only with risk that certain rewards can come.

Unpredictable Risk is Apparent in All Aspects of Life

Last weekend, I was reminded of this risk/reward relationship in a completely different context: while gazing out at a very rewarding view of the frozen Monadnock region from the top of Barrett Mountain at Windblown cross-country ski area.

The decision to head to Windblown was made as a light, seemingly innocuous snow fell in Hollis but, while in the car en route to the ski area, the weather shifted first to rain then to heavy, driving snow. The winds picked up abruptly, several hours earlier than had been forecast. As my better half and I arrived, we were greeted with whiteout conditions. I couldn’t help but question the thinking that had prompted us to leave the dry, warm house and venture out into this mess. But hey, we’d made the trek, we were there, and it couldn’t be any worse than the New Year’s Day conditions, could it? Or maybe we should just duck into the lodge, buy a hot chocolate, and watch the other crazies battling the storm?

Opting to head out on the trail at that point was just the first in a series of calculated risks that ended up being rewarded handsomely. These decisions included: Do we ski our favorite trails, or stick close to the lodge? Do we try to follow the Snocat, or venture onto ungroomed trails? Should we stay on green circle (easiest, least hilly) trails, and skip black diamond (most difficult, steepest) trails even if they take us where we want to go? In the end, we kept choosing what could be characterized as the riskier path, but not without fallback positions, knowledge of the trails, and previous experience. The thinking was: we’ve seen these conditions before, we are keeping our options open, and we’re not shy about breaking out emergency techniques such as snowplowing or sidestepping down if a particularly treacherous hill demands it.

Sure, we got lucky too, as sometimes happens, and the storm turned out to be more of a squall. The winds died down. The whiteout abated. As we made our way up the last leg of the Zig-Zag trail, (“and I swear I am not making this up” as Dave Barry would say), the sun broke though and blue sky prevailed. We were rewarded with a perfectly clear view of the snow-covered mountains for miles around, a very unexpected outcome to say the least.

Know Your Risk Tolerance

Now snow isn’t money, skiing isn’t investing, and I still have no idea when the sun will break through the clouds of this current economic climate. But the point I’m trying to make is that, in investing as in skiing, while the green circle route can be wonderful in its own way, it simply can’t be expected to deliver the same kinds of rewards that result from taking the black diamond. For some people, the green circle may get them to precisely the destination they seek, in which case it’s the perfect choice. The problems happen when green circle folks get lured onto black diamonds by the promise of greater rewards. In certain conditions, it is tempting to believe that, despite all indications to the contrary, somehow this time, there will be only nice smooth, gradual upslopes. The reality is that, eventually, the true nature of the black diamond will emerge, and the terrain will turn steep and challenging. That’s fine for the aggressive skier/investor, not so good for others.

To sum up, when it comes to investing, there are a few lessons to take away from skiing Windblown in a blizzard… ok, squall:

  1. If you‘re a green circle or even a blue square investor, you’ll be very uncomfortable in a black diamond portfolio, especially on the steep downhills. And there WILL be steep downhills.
  2. You can’t have it both ways. Green circle (i.e. safe) portfolios bring green circle (i.e. relatively low) returns. Black diamond (i.e. more aggressive) portfolios have the potential to deliver significantly higher rewards, but you also have to accept the greater risk of falling and having to pick yourself back up en route.
  3. Regardless of which type of investor you are, if you make choices that fit your skill/experience level and temperament, you’ll have a much more rewarding experience overall. This is what’s meant by having a financial plan that fits you. It’s also why there’s no such thing as a “good investment.” The question to be asking is: Is it a good investment (or investment strategy) FOR YOU?
  4. With experience (“seen this kind of market before”), use of various techniques (e.g. emergency fund), perseverance, and a little luck, the chances of experiencing the rewards that come with black diamond investing without falling are much, much greater.

The same is true in skiing. And I can’t prove it, but I’m convinced that the hot chocolate in the lodge tasted sweeter AFTER the Zig-Zag trail than it would have if we’d headed straight in upon arrival.

About the author

Sherrill St. Germain, CFP®

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