Volatility Returns With a Vengeance

Thursday's harrowing 1,000-point intraday decline in the Dow Jones Industrial Average was a dramatic exclamation point on a tumultuous week in the global stock markets.

Whether Thursday's plunge was attributable more to market fear, trading errors or technological glitches is a question that is still being studied by the stock exchanges and regulators. And, in some ways, it is beside the point, because it is clear that volatility has returned to the global capital markets whatever the cause may be.

Greece's sovereign debt crisis is largely being blamed for the return of fear to the markets, and indeed there is a legitimate concern that Greece's fiscal problems could wash out into other Eurozone countries and then to Asia and America, potentially sidetracking the global economic recovery.

On the other hand, it is worth remembering that we have been on a virtually uninterrupted upward climb in the market since March 2009, a 14-month period of time that saw the Dow gain upwards of 70% and the Russell 2000 small cap index gain more than 100%.

From that perspective, then, the market has been overdue for a significant downturn, and in the crisis in Greece the market has all the reason it needs to have one. The real question for long-term investors is...what to do about it?

Any action requires guesswork. Does the crisis end in Europe or cross the oceans? Does it increase the likelihood of a deflationary spiral or an inflationary spike? There are plenty of talking heads to argue all these possibilities, and all of them sound compelling when a compelling person is making the case. But it is important to remember that making an accurate projection about the future direction of the economy is not the same as making an accurate decision about where and when to invest one's assets. Those who bet that the dollar would crash and the Euro would become the world's reserve currency can attest to that.

Well-diversified investors don't have to worry about such guesswork. While there is no avoiding volatility in a market environment such as we have seen this week, there is solace to be found in a portfolio that is diversified across dozens of sectors and thousands of securities. For example, even while the Dow dropped more than 3% on Thursday, inflation-indexed bonds (known as "TIPS") posted healthy gains.

Volatility is the price stock investors pay for the potential of higher long-term returns. Unnecessary volatility - such as that which comes from being concentrated in, say, financial stocks - can be diversified away, but short-term market volatility can only be overcome with the march of time. Those who move in, out and around the market in an attempt to avoid it are the ones who miss the rallies when they begin and usually arrive just in time for the downturns.