Why volatility matters when investing

Two of the most significant developments in the financial markets during 2022 were the breakout of higher interest rates and the return of stock market volatility. For a glimpse of how volatile stocks were last year, consider the VIX Index, often used as a gauge of fear or stress in the stock market. In 2022, the VIX spent 91% of trading days above 20.0, which signals a high degree of market volatility. You have to go back to 2009 to find a similar consistent fear among equity investors.

Similarly, just five trading days in 2022 accounted for almost all of the S&P 500® Index’s loss of 18% for the calendar year. For example, on September 13, the S&P 500 Index fell 4.3% on news of a hotter-than-expected inflation report. Likewise, the S&P 500 fell 4.0% on May 18 as reports of weakening consumer sentiment spooked investors.

But volatility wasn’t confined to a few isolated days or months in 2022. Significant swings in the equity markets were a fact of life throughout the year. As illustrated in the chart above, almost half of the trading days in 2022 saw positive or negative moves in the S&P 500 of greater than 1.0% – a reminder that volatility occurs on the upside and the downside. Notably, on the downside, there were 65 trading days last year when the S&P 500 sank by 1.0% or more, levels not seen since 2008 (78 days) or 2002 (73 days).

When it comes to volatility, most investors welcome the upside kind, even as downside volatility tends to spark anxiety and concern. In this sense, volatility can be like a funhouse mirror, exaggerating whatever emotions investors may be experiencing at a given time. But volatility can also highlight the importance of investors understanding their risk tolerance. Spells of downside volatility can present opportunities for financial professionals and investors to re-assess risk and reset portfolio allocations if warranted. They can also be excellent entry points for long-term investors looking to buy stocks of good companies at what may be value prices.