Does stock market volatility mean opportunity?
October 26, 2011
Q: The stock market has been crazy lately, with a lot of big ups and downs. I know that scares some people off, but doesn't that kind of volatility create more opportunity to make money?
A: In a sense, price fluctuations in stocks create more opportunity, but they also create more risk. It really comes down to valuation. If you use price fluctuations to buy good stocks cheaply, then volatility can be your friend. If you get into a guessing game with the market, then volatility can make things very dangerous. In other words, beware of market timing.
Ultimately, valuation--being able to accurately assess the long-term worth of a stock--matters more than volatility. After all, risk and return don't necessarily go hand in hand. Historically, there have been high-return periods for the U.S. stock market that were marked by relatively low volatility: 1985-1986, 1995-1996, and 2003-2004, for example. In contrast, spikes in volatility have tended to characterize periods of steep losses, as in 1987 and 2008. By driving down stock prices, those periods of steep losses did, in turn, create opportunities, but only if you were playing a long-term game.
The wild card in all this is interest rates--everything from bond yields to CD, savings, and money market rates. Back when savings accounts were yielding 5 or 6 percent, it was easier to sit on the sidelines and get paid to do it. Now, with bond yields in the low single digits and savings accounts paying next to nothing, there is more opportunity risk in waiting out the market. Savings accounts are still the best choice for conservative investments, but for long-term growth, you may have no choice but to live with the stock market's volatility.
Got a financial question about savings, investing, or banking? MoneyRates.com invites you to submit your questions to its "Ask the Expert" feature. Just go to the MoneyRates.com home page and look for the "Ask the Expert" feature on the lower left.