Minimizing Volatility

Thus far for the month of May, the performance of the stock market has been a disappointment and has made the old adage “sell in May and go away” look prophetic. However, most of us realize investing in equities should be a long-term venture and works especially well when investors systematically add to their investments. When markets fall, investors are buying low as they dollar-cost average and take advantage of the dip. This process can potentially enhance return. However, when investors are pulling money out of their accounts for income needs, they are essentially reverse-dollar-cost averaging.

If there is a down year and an investor takes a withdrawal for income, they are essentially locking in a loss on the amount withdrawn. The S&P 500 has averaged 7.16 percent*, including dividends, for the 20-year period that ended in 2018. If an investor had earned the full returns of the S&P 500 on their $1 million investment for the past 20 years and withdrew $60,000 per year (6 percent of initial investment) their account balance would have ended the period worth only $273,245. However, if the investor had earned a fixed 6 percent return each year and pulled out $60,000 per year their account would still be worth $1 million after the same 20 years.

The last 20 years has taught us that a more consistent lower return may wind up being much better for those who are taking income from their investments than higher return with greater volatility. Although the stock market averaged 7.13 percent* per year for the past 20 years, most investors earned far less due to management and trading costs, taxes and poor market timing decisions. Therefore, for those in or near retirement, when evaluating investment alternatives, evaluate not only the expected return but the expected volatility as well, and overweight choices with less volatility in order to help create a higher probability of success.

*Source Yahoo Finance