Most investors think about returns first. But what gets less attention, and probably deserves more, is volatility. The ups and downs. The gut-wrenching drawdowns. Volatility is not just noise. It’s the single biggest reason many investors fail to hold on long enough to see the returns they were aiming for.
Stocks Can Swing A Lot
It’s well known that stocks, while offering long-term growth, also come with heavy short-term fluctuations. The S&P 500, as a benchmark, has seen its fair share of turbulence. During the 2008 to 2009 financial crisis, the index dropped nearly 58% from its October 2007 high to the bottom in March 2009. That’s not just a bad year — it’s a devastating blow for anyone who had money in the market and needed to act on it.
And that wasn’t a one-time event. Go further back to the Great Depression. The Dow Jones Industrial Average peaked in September 1929 and did not fully recover until late 1954. Even if you use total return data (including dividends), it took until the early 1960s to break even. That’s more than 30 years.
Or take the 2000 tech bubble. If you had invested at the peak of that bull market, your portfolio (assuming it tracked the S&P 500) wouldn’t have broken even until around 2012. That’s 12 years of no gains, not even counting inflation.
These are not outlier scenarios. These are part of the historical record.
Real-Life Consequences of Market Volatility
The numbers are one thing. But volatility creates real-world problems that aren’t as easily modeled on a spreadsheet. Here are a few common examples.
1. Investing at the Wrong Time
Many investors, particularly younger ones or those who just received a lump sum, may end up investing at or near a market peak. When that happens, their initial investment could be underwater for years. In some cases, decades. This isn’t just about bad timing — it’s about bad luck mixed with the reality of market cycles.
And while the long-term may eventually work out, the definition of “long term” varies widely. If your investment loses 50% early on, you need a 100% gain just to get back to even. That could take 10, 15, or more years depending on market conditions.
The following chart shows that it took more than 15 years to recover your investments if invested in the 1929 peak, right before the Great Depression:
2. Forced Withdrawals During Downturns
Markets don’t care about your life schedule. If you need to tap into your investment for a child’s college tuition, a down payment on a home, or unexpected medical expenses, and the market happens to be down 30 or 40%, you are locking in those losses.
This becomes even more urgent for retirees who depend on their portfolio for income. Withdrawing during downturns accelerates what’s known as sequence of returns risk — the danger of running out of money earlier because losses hit you when you’re drawing funds.
We have written numerous newsletters on this subject, see for example, September 28, 2020: Retirement Spending: Your Portfolio’s Volatility Matters.
3. Psychological Stress and Bad Decisions
Probably the most common issue is psychological. When investors see their 401(k) balance cut in half, panic starts to take hold. Some start to question their entire plan. Others simply can’t stand the stress and sell. Historically, retail investors tend to pull money out at or near the bottom and then they wait too long to get back in.
According to a 2022 DALBAR study, the average equity fund investor underperformed the market by several percentage points annually, mostly due to bad random or emotion-driving timing decisions. This isn’t just about knowledge. It’s emotional endurance, and it’s harder than people think.
Building a Portfolio That Matches Your Risk Tolerance
The first step in managing volatility is simple: don’t take more risk than you can truly handle. Many people overestimate their tolerance for loss during good times. But the test comes when things go bad.
Here are a couple of ways to build a more stable portfolio:
1. Diversify with Safer Assets
This is the oldest advice in the book, and still valid. A balanced portfolio that includes stocks, bonds, and short-term investments can reduce volatility significantly. For example, a 60/40 portfolio (60% stocks, 40% bonds) fell around 35% during the 2008 crisis. That was still painful, but far better than a full stock portfolio’s 58% loss.
Even more conservative portfolios, like a 40/60 or 30/70 stock-to-bond mix, tend to experience much shallower drawdowns. The trade-off is lower long-term returns, but the gain is higher survivability.
2. Use Tactical Asset Allocation
Another method is to adapt your exposure to stocks based on market conditions. This does not mean timing the market on a whim. It means having a rules-based strategy that reduces risk during periods of high market stress.
For example, MyPlanIQ’s Composite Allocation Indicator and our Tactical Asset Allocation Strategy (see White Papers) are built around this idea. They don’t try to predict market tops or bottoms, but they aim to sidestep the worst periods by adjusting exposure based on long-term trends and signals.
The idea is simple: during severe downturns, avoid being overexposed to risky assets. And when conditions stabilize, gradually re-enter. But not all strategies are sound. Any approach you use must be intuitive, transparent, and supported by historical data. Complexity does not guarantee better results.
Takeaway
Volatility is not just a theoretical concept. It’s the lived experience of investing. The headlines don’t prepare you for what it feels like to see years of gains wiped out in weeks. Or to sit through a decade of no returns.
Managing volatility means managing expectations, behavior, and yes, portfolio design. You don’t need to eliminate risk. That’s not possible actually. But you can build a plan that fits to what you can realistically endure.
If you can do that, you’ll have a much better chance of staying the course. And that, more than any single investment decision, is what often separates long-term success from failure.