Taking Control Amid Market  Volatility

David Rutherford, AVP, Marketing, Hartford Investments

If there’s one guarantee when you invest, it’s that there are no guarantees. Here’s another: market volatility like we’re currently experiencing will always worry investors.

But that doesn’t mean you need to run and hide every time the markets get choppy. In fact, the opposite is true: understanding the truth about market volatility and building financial strategies that will help you stay the course when markets get scary, are the first steps to achieving your financial goals.

What is Volatility?

Let’s start by facing up to the beast. What is volatility anyway? The first thing you need to know is that volatility is normal. It happens all the time in the markets. The market cycle typically includes a number of expansions and contractions that are the result of various economic, social and political factors. In fact, the market behaves like people do. Sometimes its actions make sense – and sometimes they don’t, reacting well out of proportion to an external event or influence.

That’s a long way of saying all you really need to know about volatility is that you can’t control it.

However, what you can control – and what you should control to be a savvy investor – is your reaction to market volatility. And one of the first lessons a good investor needs to learn is to not react at all.

The two charts below can help you. The first shows the short-term volatility of the S&P/TSX Index from 1972 to 2007. As you can see, the market is all over the place – that’s volatility in action: a bunch of short-term ups and downs. Those movements are what make investors really nervous and think their hard earned capital is going up in smoke. All that changes, however, in the second chart which indicates the market index has shown an upward steady trend over time.

The lesson is simple.Ignore short-term volatility and stay in the market for the long-term.

Chart #1

Source: S&P TSX Composite Index

Chart #2

Source: S&P TSX Composite Index
The Index is unmanaged and unavailable for direct investment.
Assumes reinvestment of capital gains and dividends and no taxes.

There’s a real price for running and hiding

The reality is that there’s a real price for running and hiding when markets get tough. There always has been. We can prove it. And we can quantify it.

Consider two different strategies for reacting to volatility.

Investor #1 – we’ll call him Sammy Safe – is apprehensive. He takes $2,000 out of the market and puts it into GICs every time markets go down. On the surface, that seems like a prudent strategy. Sammy’s a conservative guy and volatility makes him nervous. A little too nervous, it turns out.

Investor #2 – Sheila Smart – is opportunistic. In contrast to Sammy, Sheila adds $2000 to her equity investments when markets are volatile. It sounds counterintuitive, but we’re calling her Sheila Smart for a reason.

Just by upping her investment by $2,000 every time the markets drop 8% or more, the difference over the course of their 35-year investment horizon is, as you can see below, night and day.

Or rather having roughly $105,000 vs. almost $840,000.

Source: S&P/TSX Composite Index and Bank of Canada 91-day T-bill rates
Note: The Index is unmanaged and unavailable for direct investment. Assumes
reinvestment of capital gains and dividends, and no taxes.

This is a hypothetical example only and not everyone has $2000 to invest whenever the market drops. Nonetheless, it is a very dramatic illustration of the importance of staying invested and focusing on the long term. Investors who have historically had the most success in volatile markets are typically those who have created a long-term portfolio that is well diversified within various asset classes. The longer you stay invested, the less important the impact of short-term unpredictability becomes and the more likely you’ll achieve positive returns.

Dollar cost averaging: a time-honoured strategy for navigating volatile markets

So what’s the best way to stay invested when markets are volatile? One of the most time honoured strategies is to use dollar cost averaging, or DCA. Once you’ve made the determination that you need to stay invested, DCA ensures you get the most out of your decision. DCA is the technique of buying a fixed dollar amount of an investment – such as a mutual fund – on a regular schedule, regardless of market price. That way, you buy more when stock prices fall, and less when they go back up again. Combined with other proven investment strategies, such as diversification, DCA ensures you always participate in the market upturns and have some protection when markets go south.

The benefits of Hartford DCA Advantage Program

One mutual fund company – Hartford Investments – has come up with a program that extends the benefits of DCA even further. Rather than have the money you’ve directed to be invested through a DCA program just sitting there, Hartford DCA Advantage Program actually pays you interest on those funds. No other fund company offers this advantage. As you can see from the chart below, that means you have more money to invest.


Source: Hartford Investments

*Average of savings account posted rate at 5 major banks, as at August 22, 2007. Average rate was 1.2%. Under the DCA Advantage Program, the stated Advantage Yield Rate is not earned on the entire amount invested due to regular transfers to the target funds that will affect the daily accrual, lowering the program yield. Program yield for the hypothetical 6-month program at a 7% annualized advantage yield is 1.98%. Program yield for the hypothetical 12-month program at a 4% annualized advantage yield rate is 2.13%.

Plus, Hartford DCA Advantage Program is simple, runs automatically and permits access to the full range of Hartford Mutual Funds. Which means all you need to do is set up the program with your financial advisor, and relax. As Dr. Quincy Krosby, Chief Economist at The Hartford in the U.S. says,

"Today I would just basically sit back, turn off the TV and do something else … what we've been telling our investors, and these are people who are saving for retirement, is continue to use dollar cost averaging with a portfolio manager who's got a good, good track record during volatile periods.”

The bottom line: control your actions, don’t let volatility control you

While all the noise surrounding market volatility is guaranteed to continue – and maybe get worse – ignoring short-term changes in favour of a long-term diversified investment strategy is your key to financial success.

Here are a few final things to consider:

  1. Keep your emotions in check. Don’t let financial decisions made in times of panic derail you from reaching your long-term investment goals.
  2. Diversify by geographic regions, asset classes, sectors, and companies to help protect against volatility.
  3. Use a strategy like dollar cost averaging to take advantage of market downturns and ensure you always stay invested.
  4. Revisit your investment goals periodically to ensure your investments are aligned with your current needs and comfort level.
  5. Finally, don’t be afraid to ask for help. Consult with a Clearsight Investment Advisor to help you create a customized investment plan that’s just right for your needs.

Continuous or periodic investment plans neither assure a profit nor protect against loss in declining markets. Because Dollar Cost Averaging involves continuous investing regardless of fluctuating price levels, you should carefully consider your financial ability to continue investing through periods of fluctuating prices. Please see the prospectus for full Dollar Cost Averaging (DCA) Advantage Program details.

Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the prospectus before investing which is available from your investment professional or Hartford Investments Canada Corp. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.