Worried about market volatility? Rightfully so. The stock market in 2017 experienced historically low price movements. While this was encouraging from an economic standpoint, it also has the potential to breed complacency and lead investors into the trap of excess risk-taking. We saw the VIX, which measures expected volatility, hit a five-month high this week with simultaneous stock market declines. This has caused some speculation that unstable markets are back and we can expect choppy waters ahead. Is this something we should be concerned about?
From 2000 to 2002 the S&P 500 dropped a combined 43% and in 2008 it again dropped 36%. Both of these occurrences are considered rare events, or "black swans," but should not be taken lightly or forgotten in times of low volatility. At Altruistic Investing, we believe that true wealth is achieved by minimizing losses in down years. Do you realize that if your portfolio drops by 43%, you have to achieve gains of around 75% just to get back to break even? By some measurements the stock market has averaged 11% per year over time. This means on average you are waiting around 7 years to recover the funds you lost. This is the scenario for a strict buy-and-hold strategy in a 100% equity portfolio and good reason to diversify into other asset classes. But even if you diversify and lower your equity risk by 10%, you are still waiting 5 years and need a whopping 51% return to recover. If losses can be reduced or even prevented, you drastically shorten the time needed to recover, not to mention sleepless nights and anxiety.
Our Algorithmic Virtual Advisor seeks to do just this. By reducing risk with Dynamic Hedging Techniques, we focus on downside protection so that when the next "black swan" event occurs, you are not left with huge losses and stuck playing catch-up for the foreseeable future. Riding the market when it's going up is fun and easy, but protection in down markets helps to keep the funds stable and build wealth more effectively over time.