Related topics: stocks, investing strategy, portfolio, financial crisis, Jim Jubak
Last week, in my Nov. 18 column, I sketched out a picture of a very volatile 2011 and said that today I'd take my best shot at a strategy for how to invest through the turbulence.
I probably shouldn't be telling you this, but most of the time investing is pretty simple: Follow the trend with your money and get your emotions out of the way. And that's also the key to even as turbulent a year as 2011 promises to be.
My strategy is based on taking advantage of that "most of the time" and staying alert for the exceptions.
Markets love trends
Most of the time, markets are in a trend. Look it up yourself on a chart of something as staid as the Standard & Poor's 500 Index ($INX) or something as supposedly volatile as the iShares MSCI Emerging Markets Index (EEM, news).
If you graph the market's daily moves along with its 200-day moving average, you'll see that while the daily moves create a mountain range of jagged peaks and valleys, the smoothing average reveals a remarkably steady trend line.
Jim Jubak
So from March 2003 to December 2007, you'll see a 200-day moving average draw a very steady ascending slope. That's despite the big valleys caused by daily moves like those of March 2007, or the big peaks caused by daily moves like those of July 2007.
Even though it tracks a very different set of markets than the S & P 500, you'll see the same pattern in the Emerging Markets Index. The exchange-traded fund tracks the index back to 2003, but from May 2003 to June 2008 you'll see a very steady upward trend in the 200-day moving average. That's despite peaks like the one in April 2006 and valleys like those in May and June of 2006.
Long-term trends are your friends
If you play around with these charts, a couple of really important investing truths pop out at you.
First, the longer your holding period is, the less important the volatility on the daily chart. Peaks and valleys fade into insignificance when you're looking at an upward-trending 200-day moving average from March 2003 to December 2007 or from May 2003 to June 2008.
This observation can easily get extended into something like the extreme form of what's called buy-and-hold investing, which argues that if your holding period is long enough, you need never sell stocks. You just hold on through any volatility.
Second, it's clear from looking at these charts that this extreme form of buy and hold isn't very good advice. And that's because these "most of the time" trends are punctuated by bouts of volatility that are big enough to completely reverse the 200-day or any other trend line.
The volatility from January 2008 through August 2009 (otherwise known as the global financial crisis or the bear market of 2007) decisively ended that March 2003-to-December 2007 upward trend. Same thing happened in the volatility that stretched from November 2000 to April 2003 (otherwise known as the tech bubble or the bear market of 2000).
Even if you draw a chart all the way back to 1950, you will see clearly these great trend-busting events. Some volatility is big enough to get your attention no matter how long your holding period.
The course through volatility
Now let's apply these two observations to the year of volatility that I sketched out for 2011 and begin to turn them into an investment strategy.
As scary as the volatility has been from, say Nov. 8 through Nov. 18, it really doesn't matter much to you as an investor -- as long as the trend that, in retrospect, began in July 2009 stays intact. (It took the rally that began in March 2009 until July to reverse the downward trend and establish a new upward trend.) In fact, the volatility of the recent 10 days hardly registers on even a three-month chart of the S & P 500.
