We interviewed Geoff Considine, who provides portfolio-management software to advisers and others through his Boulder, Colo., firm, Quantext.
Stock-market volatility seems out of control. What is the Volatility Index, also known as the fear index, and what can it tell us about our investments?
The VIX measures movements in prices of options on the S&P 500 that are going to expire soon. It's just a number -- the higher it is, the higher people expect volatility to be.
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A disciplined investor who is willing to stick with a well-designed portfolio for the long haul does not need to pay attention to the VIX. The problem is that people are rarely that disciplined, and they come up on deadlines when they know they'll need to pull money out of the market. Volatility just means uncertainty -- the uncertainty that you'll earn an expected return. You could earn more or less, but uncertainty on the downside is what we worry about. Risk and volatility are interchangeable.
What's the VIX telling us now?
It has gone up a great deal since spring, when it was hanging out in the 10 to 12 range -- about as low as it gets. People were getting comfortable with the fact that they could invest more aggressively, and nothing bad ever happened. But now the VIX is up, between 20 and 25, which could correspond to market losses of 1.6% at least one day a month. Some people will find they're holding portfolios not suitable for them. I don't think most investors know how risky their portfolios are.
How can you protect yourself?
Look for stocks that are less responsive to market moves. Some examples are Anheuser-Busch (BUD), Aflac (AFL), PepsiCo. (PEP), Procter & Gamble (PG) and Public Service Enterprise Group (PEG). On the other hand, until recently, emerging markets had been running at lower levels of volatility. They've been risky all along, but with overall volatility so suppressed, we haven't seen it. The ride can get very bumpy as volatility returns.
Will the market become even more jumpy?
The VIX could go a good bit higher. During the tech wreck of the last bear market, the VIX cracked 40. It could easily get up to 40 within a year -- or within six months. That could correspond to losses of nearly 3% at least once a month.
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