The Benefits And Drawbacks Of Market Tranquility

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Includes: CVOL, IVOP, SVXY, TVIX, TVIZ, UVXY, VIIX, VIIZ, VIXM, VIXY, VXDN, VXUP, VXX, VXZ, XIV, XVIX, XVZ, XXV, ZIV
by: Adam Freedman
VIX_5_Year

After a bumpy start to 2016, the stock market seems to have calmed down. While the S&P 500 index of large US stocks moved by more than 1% on almost 60% of the trading days in the first two months of the year, it did so only three times in March. Meanwhile, the CBOE Volatility Index (often called the "VIX"), a measure of expected stock market volatility, has plunged to well below its long-term average of about 20. For investors, this tranquility provides both an opportunity and a potential pitfall.

When the ups and downs of the market are so subdued, it's easy to get complacent about the amount of risk you're taking in your portfolio. This can be especially dangerous after the stock market has risen dramatically (as it has since the middle of February), since the rally can cause higher-risk investments to become a larger portion of your portfolio. As a result, a subsequent bout of volatility can be especially gut-wrenching.

Such a return to inclement markets is a distinct possibility. While a calm stock market isn't unusual - stock market volatility often stays relatively subdued for years as a time - there are a number of factors that could make the current episode short-lived. The global economy remains weak, the Chinese economic slowdown could accelerate, and political risks abound. Any of these could trigger a renewed bout of stock market turbulence.

The current period of calm markets, therefore, provides a good opportunity to examine your portfolio and verify that you're taking the right amount of risk, based on your financial goals and your ability to handle market downturns. If you need to make a change to your portfolio to get to the right risk level, it's better to do so when markets are benign than when you're forced to at an inopportune time.