Asset Strategy

How Does Market Volatility Affect My Savings and Assets?

Gold Alliance disclaimer
Historically, gold has a lower market volatility than stocks.

Stock market analysts agree that the equity markets seem to be entering a new phase of volatility.  

Volatility is one of the least understood measurements of investment risk. In simple terms, volatility is the price swings. Or, in a more clinical language, it’s an asset’s degree of price movement within a set period compared to another asset or to its price history.  

The bigger and more frequent the price swings, the more volatile the market or stock is said to be. For example, a stock trading between $20 and $40 is considered more volatile than one trading between $25 and $30 during the same period. Similarly, a stock that traded between $25 and $30 in 2020, then between $20 and $40 in 2021, has increased its volatility. 

Volatility and retirement portfolios 

Volatility may be a trader’s paradise, but it is a retirement saver’s nightmare due to its uncertain impact on his or her savings’ ending value. A useful analogy is to think of the retirement fund like an apple orchard of a farmer. The annual crop of apples is like the retirement income from the fund: More apples harvested means higher income from the retirement fund.  

In this context, volatility is akin to violent windstorms and heavy weather during the growing season. Each time a strong wind blows, the apple trees shake, and apples fall to the ground, diminishing the size of the harvest. 

Plus 10%, minus 10% = no change? Why this is wrong 

People often underestimate the effects of volatility on a portfolio over time. They assume the same percentage swings up and down are equal and have no impact on a portfolio’s value. For example, a price decline of 10% followed by a price increase of 10% would appear to “even out,” i.e., the values before and after the changes would be the same.  

Unfortunately, the math doesn’t work that way. 

Asset volatility can have a huge impact on the value of your retirement portfolio, so it’s important you manage the volatility of your investments.

This table illustrates the effect of five cycles of price declines and price increases of 10%, 20%, 30%, and 50% from a beginning value of $100. Since the decreases and gains are the same percentage, it could seem that the ending portfolio value would equal the starting portfolio value ($100).  

As shown in the table above, that is not the case.  

In each example of volatility, the ending portfolio value is less than the beginning value. But as volatility increases, so does the decline in the portfolio’s ending value. If your stocks are seesawing in your portfolio, your apples are falling off your tree. 

Volatility’s double whammy: inflation 

Focusing on the potential losses from volatility, people often overlook the loss of purchasing power in a portfolio due to inflation. Inflation exaggerates the potential losses due to volatility. The following table illustrates the possible effects of multiple volatility rates and inflation rates over three years.  

When you combine the effects of volatility and inflation on your portfolio’s value, they can quickly drain the purchasing power of your retirement savings.

For example, retirement savings equal to the purchasing power of $100 experiencing 10% volatility and a 2% inflation rate would lose $11.50 in purchasing power over the period (11.5% loss in total value). Higher volatility and inflation rates compound the losses in purchasing power. Getting back to the purchasing power of three years prior with 30% volatility and 7% inflation requires a doubling of the portfolio value. 

Diversifying with gold can reduce portfolio volatility 

Gold ownership is a popular strategy to reduce volatility risk in a portfolio because it is considered a hedge especially sought out when financial markets are uncertain. There is economic research claiming that gold is an asset with no market risk. Gold prices typically rise when a national currency is considered unstable or when inflation worries grow. 

Many portfolio managers purchase gold to lower equity portfolio volatility and hedge against stock markets declines. While gold can exhibit short-term price fluctuations due to unusual market conditions, it is less volatile: If the price of gold declines along with other asset classes, the precious metal historically declines less than other assets.

The chart below shows the average daily volatility of various asset classes over the last 5 years, with gold being one of the least volatile assets.

The five-year average daily volatility of gold is amongst the lowest of all asset classes.

Historically, when stock prices fell, the price of gold typically rose. In the rare times when the value of both assets declined, gold has generally retained a higher proportion of its value than securities. These characteristics suggest that adding gold to a portfolio of stocks notably reduces portfolio volatility without significantly lowering overall returns. 

Understanding volatility is critical

We all know we want to reduce risk, and the professionals that help us are supposed to be doing just that. Being aware of volatility and knowing that reducing it will help your portfolio is a way where you can relatively and easily monitor how balanced your balanced is. As the famous economist Paul Samuelson once said:

“Investing should be like watching paint dry or grass grow. Manage your risks, and you’ll need a lawnmower.” 

– Paul Samuelson

May you be well and safe in these uncertain times.

Headshot of Joseph Sherman.

Joseph Sherman, CEO
Gold Alliance