Volatility in Retirement: Not a Good Thing

Earlier this month, I took a look at how volatility affects your return when dollar-cost-averaging into an investment. (In short, it increases it.)

While in St. Louis for the holidays, I had a conversation with a family member that made me think that it might be prudent to explain the other side of the equation: Volatility’s effect on returns when dollar-cost-averaging out of an investment.

The short version is that, when DCA’ing out, volatility has the opposite effect that it does when DCA’ing in. In other words, it has a significant negative effect on returns.

Why?

For the exact same reason that increased volatility helped returns when buying shares: Volatility drives the average price per share downward. Unfortunately, however, a lower price per share is not a good thing when you’re the one selling. 😉

Conveniently enough, most retired investors are already capitalizing on this fact (even if they’re entirely unaware of it) because conventional wisdom says that retired investors should own more bonds and less stocks.

Now, does this mean that when somebody retires they should move all their money into no-volatility investments? Of course not. Over time, stocks outperform bonds (even with volatility having a downward effect on return). The only way for most investors to make it through a 30-year retirement is with a large portion of their portfolio in equities.