Are Volatile Markets An Easy Way To Turn A Profit? Your Client Likely Thinks So.

The upward-moving, volatile stock market has clients thinking there is easy money to be made, leading them to uniformed and risky financial decisions.

For money managers, that’s scary.

Data from the American Institute of CPAs suggest that volatility is the new norm and Americans are looking to capitalize on it.

Even more frightening, the AICPA found that of the one third of Americans involved in household investment decisions, investors are choosing high-risk investments with three in 10 Americans doing no research into investment strategies and potential investment opportunities before making a decision.

So, why are investors making such risky decisions on the stock market?

The AICPA found that 48 percent of U.S. Adults believe the wobbly market “gives them an easy opportunity to make a profit.”

Greg Anton, chairman of the AICPA’s National CPA Financial Literacy Commission cautions against this kind of investing.

“Investing is not a get-rich-quick scheme and trying to time a volatile market with hopes for huge gains is a serious financial risk,” he said. “Many people who enter the market looking for a quick buck find they can’t handle watching their investment lose value, which leads them to sell at a loss. For most people, seeking incremental gains over a longer time horizon is a safer, more sustainable approach.”

Not Facing Reality?

A big issue with advisors who preach stability to clients is that most investors don’t seem to realize that the stock market is inherently volatile.

Tim Hai, chief investment officer with Belleros Capital Management, in Hunt Valley, Md.  says the stakes can be high for investors, so he takes extra steps to protect their portfolios in volatile markets.

“For Main Street investors, market timing is futile and impossible to continually get right,” Hai said. “Friction costs (like transaction fees and taxes) are high and opportunity costs great. In addition, real and permanent losses of capital are a high probability.”

If the market is over-valued and ripe for correction, that scenario has “almost zero” bearing for Hai and his clients. “The portfolios we have created for our clients are value based, with a built in self-discipline,” he said. “We actively cull our winners so that the aggregate portfolio reflects a value bias. We do not allow our portfolios to get overheated.”

A market decline will affect Hai’s portfolio but, with a twist, he said.  “It gives us an opportunity to double down on our best ideas or upgrade the quality of the portfolio with new opportunities, positioning it to benefit from a market rebound,” he said. “Our portfolio will be more concentrated and will bounce back more quickly and with greater force.”

Volatility Over-Touted

While the data does indicate that volatility is increasing on a daily basis, there is no evidence to suggest that volatility is increasing on a monthly or longer basis, market experts note.

Robert R. Johnson, principal at the Fed Policy Investment Research Group in Charlottesville, Va. said, “For the long-term investor, daily volatility is irrelevant. Some of this increased volatility is really a perception of increased volatility, as investors still anchor upon movements in points on the Dow Jones Industrial Average.”

The problem there is that Main Street investors see that the Dow is down 100 points and believe that is significant. “A 100-point move today on the Dow is equivalent to a 0.4 percent move,” Johnson said. “Back in mid-2011, when the Dow was at a level near 10,000, a 100-point move on the Dow represented a 1 percent move.

The old Wall Street proverb ‘nobody rings a bell at the top or bottom of a market’ is appropriate here.  Johnson said, “Investors should focus on the long-term and ignore short-term volatility.”

The Way Out For Advisors Who Underplay Risk

According to the AICPA study, there’s a big difference between investing and speculation, and it’s an advisor’s job to explain the difference to over-zealous clients.

“Investing is usually considered lower-risk and longer-term focused, whereas speculation is high-risk and short-term focused,” the AICPA stated in its report. “An investor’s understanding of their own risk tolerance, the potential amount of money they can endure losing, is essential when building a balanced portfolio.”

Investment time horizon, a client’s net worth, income and portfolio liquidity will also have a major impact on a client’s risk tolerance. “Yet, a well-researched and properly diversified portfolio that matches an investors risk tolerance will give confidence to stay focused on long-term strategy and protect from the temptation to sell during short-term price swings,” Anton said.

In a rising interest rate environment, where large cap stocks perform markedly worse than in a falling interest rate environment, caution is the watchword for investors who tend to grow more aggressive – and who push their advisors to handle their portfolios accordingly.“I believe that rising interest rates will precipitate a reversion to the mean in stock returns (and stock valuations) and investors who continually monitor their investments will become less comfortable with investing in the stock market,” Johnson said. “Those investors that play the long game and ignore short-term volatility will be the winners.”

Buying The Dip Always OK

Of course, there is opportunity in market fluctuations, and advisors like to point those out to clients.

Tim Holland, investment strategist at Brinker Capital’s Global Investment Strategist said,

“If one has an appropriate timeframe and can tolerate near term volatility, buying the dip in US equities has historically been rewarded. For example, over the past 38 years, the S&P 500 has experienced an average intra year draw down of about 14 percent while going onto close higher in 29 of those 38 years.”

Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at brian.oconnell@innfeedback.com.

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