The Prosperity Protocol

Issue #12 – June 23, 2025

Editor’s Note: Todd here, and welcome to the twelfth issue of The Prosperity Protocol!

Your responses to our inflation protection strategies have been fantastic—many of you are already implementing tiered emergency funds and adjusting your portfolios for better inflation resistance. It's exciting to see you taking these concepts and making them work in your own financial lives.

This week, we're tackling a topic that every investor faces but few truly understand: Understanding Market Volatility and Staying the Course. Whether you're a brand-new investor watching your first market downturn or someone with experience still struggling with the emotional rollercoaster of investing, mastering this topic is crucial for long-term wealth building success.

The Volatility Paradox: Why the Scariest Part of Investing Is Also the Most Normal

Have you ever checked your investment account during a market decline and felt your stomach drop, even though you know you're investing for the long term?

That gut-wrenching feeling is completely normal, but it's also one of the biggest threats to your financial success. Market volatility—the natural up-and-down movement of investment prices—is simultaneously the most predictable and most psychologically challenging aspect of investing.

A close friend of mine learned this lesson viscerally during the March 2020 market crash. Lisa, a good friend of mine, who had just started investing six months earlier, watched her $5,000 portfolio drop to $3,800 in a matter of weeks. Despite everything she'd read about long-term investing, seeing that $1,200 "loss" on her screen felt devastating. She called me in a panic, ready to sell everything to "stop the bleeding."

I convinced her to wait 24 hours before making any decisions. During our conversation, I walked her through market history, explaining that what felt catastrophic to her was actually a normal market correction that happens regularly. More importantly, I helped her understand that those scary red numbers weren't actual losses unless she sold—they were temporary price fluctuations.

Lisa stayed invested, and within six months, her account had not only recovered but reached new highs. That experience taught her (and reminded me) that the ability to stay calm during volatility is often more important for investment success than picking the perfect stocks or timing the market.

Your Volatility Mastery Blueprint

Let's explore how to understand, prepare for, and navigate market volatility with confidence:

1. Understand What Volatility Really Means for Your Wealth

Market volatility isn't a bug in the investment system—it's a feature that creates long-term returns:

Why Markets Are Volatile:

• Economic uncertainty: Markets reflect collective uncertainty about future business conditions

• Emotional reactions: Fear and greed cause prices to swing beyond fundamental values

• Information processing: Markets constantly adjust prices as new information becomes available

• Leverage and speculation: Borrowed money and short-term trading amplify price movements

• Global interconnectedness: Events anywhere in the world can impact markets everywhere

Historical Volatility Context:

• Average annual volatility: The S&P 500 typically experiences 15-20% volatility annually

• Intra-year declines: Even in positive years, markets often decline 10-15% at some point

• Bear markets: 20%+ declines happen roughly every 3-5 years on average

• Recovery time: Most bear markets recover within 1-3 years

• Long-term trend: Despite volatility, markets have trended upward over decades

The Volatility-Return Connection:

• Risk premium: Stocks provide higher long-term returns partly because of their volatility

• Short-term pain, long-term gain: Accepting volatility is the price of superior returns

• Time arbitrage: Patient investors get paid for providing stability to impatient ones

• Compounding benefit: Reinvesting during volatile periods often enhances long-term returns

Michael, who's been investing for 15 years, shared his perspective on volatility: "I used to see market declines as threats to my wealth. Now I understand they're the reason stocks provide better returns than bonds or cash. The volatility that scares people away is exactly what creates the opportunity for patient investors to build serious wealth over time."

For Beginners: Understand that volatility is normal and temporary, while the long-term upward trend of markets is the foundation of wealth building.

For Intermediates: Use your understanding of volatility cycles to maintain perspective and potentially take advantage of opportunities during market dislocations.

2. Build Mental and Financial Frameworks That Handle Volatility

Successful investing during volatile periods requires both psychological preparation and practical systems:

Mental Preparation Strategies:

• Historical perspective: Study past market cycles to understand that recovery is normal

• Focus shift: Train yourself to think in years and decades, not days and weeks

• Process over outcomes: Judge success by following your plan, not short-term results

• Zoom out regularly: Review long-term charts instead of daily price movements

• Expected volatility: Build the assumption of 20-30% annual swings into your expectations

Practical Volatility Management:

• Appropriate risk tolerance: Don't invest money you'll need within 5 years in volatile assets

• Emergency fund buffer: Maintain 3-6 months expenses to avoid forced selling during downturns

• Automated investing: Set up systems that continue investing regardless of market conditions

• Rebalancing discipline: Use volatility as opportunities to buy low and sell high systematically

• Media consumption limits: Reduce exposure to daily market commentary and fear-inducing headlines

The "Volatility Budget" Concept: Think of volatility like a budget—you're "spending" comfort in exchange for higher returns:

• Conservative portfolio (60% stocks): Budget for 15-20% annual swings

• Moderate portfolio (80% stocks): Budget for 20-25% annual swings

• Aggressive portfolio (100% stocks): Budget for 25-35% annual swings

Sarah implemented a volatility management system after struggling with market swings: "I created what I call my 'volatility rules.' I only check my accounts monthly, not daily. I set up automatic investments that continue regardless of market news. And I remind myself that if my account drops 20%, that's not a crisis—it's Tuesday in the stock market. These rules have kept me invested through three major market corrections."

For Beginners: Start with more conservative allocations until you've experienced volatility firsthand and know your true risk tolerance.

For Intermediates: Develop systematic approaches to rebalancing and potentially increasing investments during market downturns.

3. Turn Volatility into a Wealth-Building Advantage

Advanced investors learn to use volatility as a tool rather than just enduring it:

Dollar-Cost Averaging During Volatility:

• Automatic advantage: Regular investing naturally buys more shares when prices are low

• Emotion removal: Systematic investing eliminates timing decisions during stressful periods

• Volatility amplification: Higher volatility actually improves dollar-cost averaging results

• Simplicity benefit: No complex strategies needed—just consistent contributions

Strategic Rebalancing Opportunities:

• Sell high, buy low: Volatility creates opportunities to rebalance at favorable prices

• Discipline requirement: Rebalancing forces you to buy assets that feel scary but are on sale

• Frequency optimization: Rebalance when allocations drift 5-10% from targets, not on calendar schedules

• Tax efficiency: Use rebalancing opportunities in tax-advantaged accounts when possible

Volatility-Based Strategies for Advanced Investors:

• Covered call writing: Generate income during sideways volatile markets

• Put selling: Get paid while waiting to buy quality stocks at lower prices

• Tactical asset allocation: Temporarily adjust allocations based on volatility levels

• Quality focus: Use downturns to add positions in high-quality companies at discounts

Building "Volatility Resilience":

• Diversification across time: Spread investments across different economic cycles

• Income generation: Build portfolios that produce cash flow independent of price movements

• Quality emphasis: Focus on companies and funds that can weather various market conditions

• Patience cultivation: Develop the temperament to benefit from others' short-term thinking

Jennifer used volatility strategically during the 2022 market decline: "Instead of panicking when my portfolio dropped 18%, I saw it as a sale. I accelerated my investment contributions and even moved some money from bonds to stocks. When markets recovered in 2023, those 'scary' purchases at lower prices became my best-performing investments. Volatility stopped being something that happened to me and became something I could use."

For Beginners: Focus on consistency and staying invested rather than trying to profit from volatility immediately.

For Intermediates: Develop systematic approaches to take advantage of volatile periods through rebalancing and potentially opportunistic investing.

Beyond the Basics: Advanced Volatility Concepts

Understanding Different Types of Volatility Not all volatility is the same—trending volatility (markets moving in one direction with swings) differs from sideways volatility (markets moving in ranges). Understanding these patterns can inform strategy adjustments.

Volatility Clustering and Cycles Markets tend to go through periods of high volatility followed by periods of low volatility. Recognizing these patterns can help set appropriate expectations and preparation strategies.

Global Volatility Considerations International diversification can reduce portfolio volatility, but during crisis periods, correlations often increase, reducing diversification benefits when you need them most.

Behavioral Finance and Volatility Understanding cognitive biases like loss aversion, recency bias, and herding behavior helps explain why volatility feels worse than it actually is for long-term investors.

Money Term Made Simple: Beta and Standard Deviation

Beta measures how much an investment moves relative to the overall market. A beta of 1.0 means the investment moves in line with the market, while higher beta indicates more volatility.

Standard Deviation measures the range of an investment's returns around its average. A higher standard deviation means more unpredictable returns.

For example:

• Investment A: 10% average return, 5% standard deviation (returns typically between 5-15%)

• Investment B: 10% average return, 20% standard deviation (returns typically between -10% to 30%)

Both have the same average return, but Investment B is much more volatile. Understanding these measures helps you:

• Choose investments matching your volatility tolerance

• Build portfolios with appropriate risk levels

• Set realistic expectations for different investments

• Compare risk-adjusted returns across different options

When building your portfolio, consider both the potential returns and the volatility you're accepting to achieve those returns.

Your Questions, Answered

Question from Alex R.: "I started investing six months ago and my portfolio is down 12% despite the market being positive this year. This makes me want to stop investing entirely. Am I doing something wrong, or should I change my strategy?"

My take: I completely understand your frustration, Alex—seeing negative returns while the market is positive feels discouraging. But before making any dramatic changes, let's examine what might be happening and why this experience is more common than you think.

Possible explanations for underperforming the "market":

• Timing of investments: If you invested a lump sum before a market decline, you might be experiencing normal timing variance

• Portfolio composition: Your specific investments might differ from broad market indices that make headlines

• Sector concentration: If you're heavy in certain sectors (like growth stocks or international), you might lag during periods when other sectors lead

• Recent volatility: Six months is an extremely short time period—even good investments can underperform for months or even years

What NOT to do:

• Don't stop investing entirely based on six months of performance

• Don't chase whatever's working right now (this often leads to buying high)

• Don't constantly change strategies based on short-term results

• Don't compare your portfolio to cherry-picked market indices or success stories you hear about

What TO do:

• Review your investment selection to ensure you have broad diversification

• Continue making regular contributions regardless of current performance

• Focus on your 5-10 year goals rather than 6-month results

• Consider if your investments match your risk tolerance and timeline

Remember: Even the S&P 500 has experienced negative returns for periods of 1-2 years multiple times throughout history, despite its strong long-term performance. Six months of underperformance tells you almost nothing about your long-term investment success.

The best investors are often those who stay consistent through both positive and negative periods rather than those who try to optimize every short-term outcome.

Tools That Make Volatility Management Easier

Managing volatility effectively requires the right tools and information sources:

1. Portfolio Visualizer – For Historical Volatility Analysis
Portfolio Visualizer provides free tools to backtest different portfolio allocations and see how they would have performed during various market conditions. You can analyze maximum drawdowns, volatility measures, and recovery times to better understand what different investment strategies feel like during difficult periods. The basic service is completely free.

2. Schwab Intelligent Portfolios – For Automated Rebalancing
Schwab's robo-advisor automatically rebalances your portfolio during volatile periods, taking emotions out of the equation. The service is free (no advisory fees) and maintains your target allocation by systematically buying low and selling high during market swings. Minimum investment is $5,000.

3. Calm or Headspace – For Stress Management
Since volatility's biggest impact is often psychological, meditation apps can help you maintain perspective during market turbulence. Both apps offer guided meditations specifically for anxiety and stress management. Monthly subscriptions range from $7-15, but many employers offer free access through wellness programs.

All three tools help you either understand volatility better or manage its psychological impacts more effectively.

Three Things to Do This Week

1. Calculate your portfolio's historical volatility by looking at your account statements over the past year and noting the largest peak-to-trough decline you've experienced.

2. Set up automatic investment contributions if you haven't already, removing the need to make investment decisions during volatile periods.

3. Create a "volatility action plan" that outlines what you'll do (and won't do) if your portfolio declines 10%, 20%, or 30% to prepare yourself mentally for future market stress.

Let's Keep the Conversation Going

Want more detailed strategies for managing market volatility? Check out my Medium publication "Investor's Handbook" where I explore these topics in greater detail.

Visit My Medium Publication → Here

How do you handle market volatility? Reply to this email with your strategies—I'd love to feature reader approaches in our next issue.

Found this helpful? Share it with a friend who might be struggling with market swings. New to the newsletter? Subscribe below to join our growing community.

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Remember – volatility is the price you pay for superior long-term returns. The investors who accept this reality are the ones who build lasting wealth.

Until next week,
Todd

This newsletter is for educational purposes only and doesn't constitute investment advice. Always do your own research and talk to a qualified professional before making investment decisions.