How To Manage This Week’s Unprecedented Volatility

In an interview yesterday on Marketplace, Robert Whaley, father of the Volatility Index (VIX) that measures whether or not there is too much fear or optimism in the financial markets, said that at the “beginning of the week VIX was about at a level of 12, at the end of the week it was at 28. That was the biggest percentage increase the VIX has ever had in its entire history.”

Whatley added that the VIX is “a measure of the volatility you expect over the next 30 days.”

If he’s right, the next month is going to be extremely volatile. This not only applies to the stock market but also to our world in general.

This leads me to a non-intuitive lesson I learned years ago: in volatile times, too little risk is dangerous.

To illustrate, let me use a silly example…

Zombies take over the world, causing chaos to reign. In panic, you take all your money out of the bank and hide it under your mattress. Zombies burn down your house, and you are left with nothing.

In retrospect, you could have left some money in the bank. You also could have – in no particular order – moved some money to: gold coins, canned food, an anti-Zombie ray gun and panic room, and a few bank accounts on island nations like Australia, where the zombies have not yet spread.
Back to the real world. This line of thinking is described in the book Real Options by Martha Amram and Nalin Kulatilaka. The book explains that “an option is the opportunity to make a decision after you see how events unfold.”

Imagine if you could place a bet on a blackjack hand after you see which cards you are dealt. That might be slightly more profitable than betting ahead of time, wouldn’t it?

Here’s more from the book:

On the decision date, if events have turned out well, you’ll make one decision, but if they have turned out poorly, you’ll make another. This means the payoff to an option is nonlinear — it changes with your decision.

The way to put this advice into action is to adopt the following mindset:

Preserve your options as long as possible.

If you’re not sure whether or not your company will survive the next six months, don’t just quit and look for a job. Instead, keep doing your job but also start networking like crazy and unearth other potential employment. Let’s say this takes three months. At that time, you may have several options:

1. Stick with your current job.

2. Take job offer A.

3. Take job offer B.

4. Take consulting opportunity C.

Volatile times create opportunities, but only for those who have kept many options open. It is highly dangerous to enter such times with only one or two options.

This line of thinking applies to almost any profession or personal situation. Unless you can see with absolute certainty your next 20 years, it will be in your interest to preserve as many options as possible. Pick up new skills, make new connections, and diversify your investments.

But when China’s growth is dropping off a cliff, oil is less valuable than water, and the Dow Jones Industrial Average (DJIA) bounces around 600 points on a daily basis… you can’t afford to take too little risk.