Saturday, June 25, 2016

Brexit and Stock Market Volatility

You probably heard the news about the Brexit vote results on Friday, June 24, in which a majority of United Kingdom voters voted to leave the European Union (EU). If you caught any financial news, you heard that global stock markets dropped a lot in response. I'll discuss the stock market reaction in more detail below, but the most important message for long-term investors is to not worry about daily stock market volatility. As I've discussed before, worrying about daily financial and economic news can be detrimental to your emotional health, and if you act on scary-sounding news or daily stock market volatility based on emotions, it also can be detrimental to your wealth.

US financial news tends to focus on US stock markets, and although the one-day drop in US stocks on Friday was relatively large, the drop in international stocks, especially European stocks, was much larger. So although you may have heard that "the Dow " (Dow Jones Industrial Average) dropped more than 600 points, the more rational way to talk about the change in stock values is in terms of the percentage change in the stock funds that you are invested in; very few people invest in "the Dow".

If you follow my advice, you probably own something like the Vanguard Total Stock Market Index Fund (VTSMX/VTSAX/VTI) and the Vanguard Total International Stock Index Fund (VGTSX/VTIAX/VXUS). I'm showing the "ticker symbols" for the three share classes of these funds in parentheses, which are Investor Shares, Admiral Shares, and ETF shares respectively. Admiral Shares and ETF shares have slightly lower expense ratios, but all share classes of a fund hold exactly the same stocks. Below are Friday's change in values for the Admiral Share class of these two funds (minimum investment $10,000):

VTSAX: -3.65% (US stocks)
VTIAX: -7.09% (International stocks)

So here we see that international stocks dropped almost twice as much as US stocks. Although most people don't (and probably shouldn't) own a separate European stock fund, we can look at Friday's change in the value of Vanguard European Stock Index Fund (VEURX/VEUSX/VGK) to see that the drop was even more dramatic for European stocks:

VEUSX: -10.56% (European stocks)

This is a really big one-day drop, and although it may be difficult not to react to it emotionally, it helps to put this in perspective by looking at a slightly longer time period. As recently as June 14, less than two weeks ago, VEUSX share price was 56.99, so the Friday share price of 55.99 is only about 1.8% lower than that. So rather than freak out about a one-day drop of more than 10%, you could reframe it as a drop of less than 2% in a little less than two weeks.

Similarly, VTIAX share price was 23.28 on June 14, so Friday's price of 23.08 represents a drop in the total international stock market of less than 1% in a little less than two weeks. If you hold 40% of the stocks in your portfolio in the total international stock market (as do the Vanguard Target Retirement and LifeStrategy funds, which I highly recommend), and stocks are 80% of your portfolio, then this represents a drop of less than 0.3% of your portfolio in a little less than two weeks--hardly worth losing any sleep over.

Looking at a slightly longer time period, on February 11, a little more than four months ago, VEUSX share price was 54.70, so even with Friday's dramatic drop, this European stock fund is almost 2.4% higher than it's low point for the year.

Similarly, VTIAX share price on February 11 was 21.34, so Friday's price of 23.08 for this total international stock fund, which is more likely what you own, is more than 8% higher than it's low price of the year. So by reframing your perspective from the one-day change to the change over a few months, you have a gain of more than 8% instead of a loss of about 7%.

It is widely expected that the prospect of Britain exiting the EU will continue to result in relatively high volatility in global stock markets, so we shouldn't be surprised to see more big down days (and some big up days) in the coming days and weeks. Although it's unlikely that Friday's drops were enough to trigger any rebalancing or tax loss harvesting, because of gains earlier in the year, further decreases in stock prices could do so. If you have an investment policy, which you should, then you can ignore daily volatility, other than possibly as a reminder to check your portfolio values to see if any policy rebalancing has been triggered.

9 comments:

  1. Yet another splendid reminder to not let the daily noise distract you from your long term goals.

    However, I do think you mean June 24th :)

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