Building Volatility Into Your Financial Plan

Nobody likes seeing their investments decrease in value, yet volatility is a part of investing. Short-term ups and downs are part of the price paid to reap long-term rewards. JP Morgan illustrates this on a website titled Investing with Composure, providing a look at historical volatility. 

There are things you can do to manage volatility, most importantly, create an asset allocation based on your objectives. In doing so you should own different types of assets such as stocks, bonds, cash, real estate, commodities, etc. A financial plan takes all of your resources into account and aligns them with your financial needs and goals, which can guide your investment strategy. 

Recent years have generally been very favorable for investors, whether invested in stocks, bonds, real estate or cryptocurrency. I’ve been reminding clients that we’ve had the wind at our backs and there will be times when the wind shifts and we’ll face a headwind, as this year has shown. It’s impossible to know when those changes will occur, but it is possible to model how those changing environments may impact your financial plan.  

Below are three charts to illustrate how you can evaluate whether your resources are on track to meet your goals by modeling potential outcomes.  

This first chart shows a portfolio value earning a nice steady rate of return. Many retirement calculators use an assumed rate of return and will look something like this chart. However, we know in the real world that even if your long-term average return is 7% for example, you won’t get 7% year after year, you will have up and down years. 

Chart 1

The next chart takes into account the reality of up and down years and models a potential outcome for the investments owned based on historical information, incorporating variable market conditions. This depicts what will likely be a more typical experience.

 Chart 2

This last chart essentially shows the 2nd chart run for 1,000 trials with different market conditions, illustrating the large range of outcomes. You can see there is a dark line essentially showing an average outcome and a lighter shaded area if you happen to have favorable market conditions (which is out of your control) or a darker shaded area if you have poorer conditions (note, this chart is not illustrating the top or bottom 20% of outcomes).

Chart 3

It is important to recognize our limits on the ability to see the future. Therefore, when planning your finances and retirement the best information available should be used to make wise decisions to prepare for an uncertain future. As new information becomes available adjustments can be made along the way. Financial planning is not a one-time event but an ongoing process of evaluation to increase your odds of success.

 If you would like to evaluate if your financial plan is prepared for the reality of market volatility, feel free to reach out at advisor@blakegallion.com.