I saw last week where the volatility index for the stock market was running near an all time high, which comes as no surprise to me, given the 200 and 300 point swings the market seems to be experiencing on almost a daily basis. This is driven by an uncertainty over how the financial/banking crisis will shake out, fueled by the growing reliance on programmed computer trading by institutional traders.
Amid these wild short-term price swings, I received an email asking my opinion on the impact this short-term volatility will have on the longer-term performance of the stock market, and my response was, “likely no impact at all.”
In the short-run, the stock market is driven almost completely by the emotions of investors. In the long-run it is impacted by the growth and fundamentals of the underlying businesses that make up the stock market.
To that end, despite the crisis in the financial sector, the economy isn’t in a free-fall in terms of growth and productivity. Yes, unemployment is rising, and yes, the housing sector, a driving force in the economy, is in a tailspin. But we need to remember that our country is coming off a period of red-hot growth in the economy, and a certain amount of contraction is to be expected.
It is no fun to watch portfolios decline day after day and week after week, but one way to get through this period with your emotions intact is to avoid watching the fluctuations of your accounts every day. If you have created an asset allocation that is right for you based on your long term financial planning, a sell-off in the stock market of this magnitude won’t affect you long-term because your fixed income (bond, CD) holdings will cushion the downside during these months.
Longer-term, there is a strong chance that the stock market will be significantly higher two to five years out, and your stock market allocation will be positioned to take advantage of that.
If you haven’t created a financial plan that brings clarity to your longer-term financial picture, now is the time to establish one.