Nobody Cares about Volatility

Seriously, there’s a lot of panic going on in social media about how the markets are so volatile due to the pandemic and the election. Thing is, who cares and you shouldn’t care as well. Hopefully that caught your attention, but if you’re saving for retirement then generally you shouldn’t care about volatility. I’ll go over several types of investors and how volatility impacts them.

Retirement Savings Investors / Long-Term Investors

These investors including myself receive a paycheck from their employer and deposit a portion toward retirement. These are usually in retirement accounts such as 401ks and IRAs. For simplicity’s sake, I’m also including long-term investors who usually buy and rarely sell unless if it’s for portfolio allocation purposes. As long-term investors, volatility rarely impacts this group as they typically invest periodically regardless of volatility. Pension and retirement funds are also included in this basket. In terms of investment philosophy, these investors tend to follow fundamentals.

Certain Hedge-Funds and Algorithmic / Day Traders

These investors typically have a shorter term focus and either generate their revenue through arbitrage opportunities or by writing options to collect premiums or trading them. Algorithmic traders have been successful in this area and they primarily utilize bots and machine learning to find arbitrage opportunities and execute millions of transactions every day, which is why day trading isn’t recommended. Volatility definitely impacts this group as it has a large impact on options and could potentially wipe out a fund. These investors tend to follow technical trends.

For the purposes of this article, we’re going to be focusing on the former. Again, we mainly don’t care about volatility in the long-term as we’re focusing on the long-term. Instead, typical questions when deciding to invest include macroeconomic trends for index fund / ETF investors and growth and moats for active investors who select individual companies. Additionally, see below several charts of various indices (names listed below).

  • FAGIX: Fidelity Capital & Income Fund
  • FBNDX: Fidelity Investment Grade Bond Fund
  • QQQ: Invesco Series 1 (follows NASDAQ 100)
  • VFIAX: Vanguard 500 (follows S&P 500)
  • VSMAX: Vanguard Small-Cap
Historical quote data sourced from Yahoo Finance. Projected values are using Monte Carlo calculations.

The chart above spans across 20 years of historical data and includes 2 years of projected quotes, which are using Monte Carlo calculations to project these values. What’s interesting is that VFIAX (Vanguard S&P 500) has outperformed QQQ (Invesco Trust) with the projected values following the same trend. Let’s take a closer look at these two indices.

Historical quote data sourced from Yahoo Finance. Projected values are using Monte Carlo calculations.
Historical quote data sourced from Yahoo Finance. Projected values are using Monte Carlo calculations.

When we look at QQQ’s prospectus, we see that they closely follow the NASDAQ 100 index, which focuses on the top 100 most innovative companies. Upon further digging, we find that QQQ has taken 16 years to recover from the dot-com crash of the early 2000s. Additionally, investors pulled a record $3.5 billion in a single day in September of this year due to uncertainty in U.S. presidential elections, vaccine development, and congressional response to further stimulus measures. VFIAX experienced a similar drop however it wasn’t as severe as QQQ. Unfortunately, Yahoo Finance data doesn’t provide quote data earlier than 2000 but I wouldn’t be surprised if NASDAQ 100 was initially growing faster than the S&P 500 but fell due to the dot-com crash and has failed to recover ever since. This is why diversification is key so you can protect yourself from significant downsides such as a crash in the market.

If you had invested in a 100% equity portfolio evenly consisting of QQQ, VFIAX, and VSMAX since 2000, you would have quadrupled your money with today’s prices even with the dot-com crash, pandemic, and the 2007 financial crisis. Thus, always continue investing and don’t touch the money until you retire. Compounding returns really go a long way!

UPDATE:

Adding a chart to show that timing of the market doesn’t matter:

Source: PortfolioVisualizer.com

The chart spans about 20 years from 1999 which is the inception of QQQ. Portfolio 1 consists of 100% QQQ while Portfolio 2 is a 50/50 mix between stocks and bonds. As long as you continue contributing every year and not withdraw funds, you would have been a millionaire. Thus, time in the market beats timing the market. Have your dollar work for you!

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