Stern Advice: Learning to love the volatility
WASHINGTON (Reuters) - Whiplash! On 18 different trading days in September the Dow Jones industrial average swung by at least 200 points. In one week, it moved more than 400 points a day for four days straight. One day last week, on October 4, it abruptly reversed a sharp drop to jump more than 400 points in less than an hour at the close.
Get used to it. Those sharp swings are likely to be part of the landscape, as trigger happy computer traders move large amounts of money in and out of stocks in seconds, while the market's long-term direction remains uncertain in the absence of clear signs from Europe, the U.S. economy, federal deficit cutters and more.
Of course, it's easier to take those volatile shifts when they are on the upside, sending averages and portfolios skyward. But if you want to feel good about your finances regardless of the direction of the daily lurch, consider using the volatility, instead of avoiding it. Here are some ways to do that.
-- Pay attention. It's one thing to set up an automatic investment plan and not panic every time the market changes direction. But the old "set it and forget it" strategy seems a tad out of touch now. "Investors are better served with a buy-and-monitor strategy as opposed to simply buy-and-hold," says Jason Ware, an analyst with Albion Financial Group. He suggests that investors keep an eye on the market and, more importantly, on what's going on in the economy. "This keeps the investor more nimble."
Does that mean you want to day trade? Probably not. But if you have a list of stocks you want to buy and shares tumble, you could be ready to go in and pick them up. You could also be prepared to sell losing stocks (to lock in tax losses) on those killer down days.
-- Buy strategically. Long-term investors are often encouraged to "dollar cost average." That's when you invest the same amount at regular intervals, such as $200 a month, in the same mutual fund or exchange traded fund. The advantages of that are magnified in a volatile market. When prices are down, you will buy more shares (at a lower average cost) than when prices are high.
But you can magnify that advantage even more by using a technique called "value cost averaging." To do that, you adjust the amount you invest every month, based on the price moves of the security. So, if you put in $200 the first month, and the price of the stock or fund falls 4 percent, the next month, you would put in an additional 4 percent -- investing $208 instead of $200. If the share price rises, you would adjust your investment downward instead.
-- Bet on volatility. Instead of guessing whether shares will go up or down, you could somehow put money down on the idea that volatility will reign. After all, the VIX, an index that measures the volatility of the Standard and Poor's 500 stock index, is up 104 percent so far this year. One ETF -- the ProShares II VIX Short Term Futures ETF -- gained 124 percent in the three months between July 8 and October 10, according to Lipper, a Thomson Reuters company. But investing in those VIX-linked funds is risky and best left to investors who understand market fundamentals and technicalities, says Jeff Tjornehoj, a Lipper analyst.
-- Play it safe. Instead of riding volatility, you could try to insure against it. Ware says volatility is usually reflective of fear, so safe assets like gold and Treasury bonds will continue to do well when volatility spikes. Some funds, like the Bridgeway Managed Volatility Fund or the SEI Managed Volatility Funds, aim to pick up most market gains while damping volatility. Kevin Crowe of SEI says his funds do that by aiming at market sectors, like consumer staples, that have lower rates of volatility, and then by filling in with companies, like ExxonMobil or IBM, that tend to be more stable.
-- Cherry-pick the stocks you buy. During the big moves of 2009 and 2010, stocks in the same sector were well correlated with each other, for the most part. But recent volatility is resulting in a situation where individual stocks are going their own way more. That's partly a result of big sector themes having played themselves out, according to Ware. For example, he pointed to the retail sector. "The easy money has been made. Next year you're going to have to mine through for the best in breed and look for good sustainable brands."
(Editing by Steve Orlofsky)