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Understanding Stock Market Volatility?

Source: www.HealthcareFinancials.com

According to Wayne Firebaugh CPA, CFP®, CMP™ the many quantitative methods of stock, bond, derivatives, alternative assets and mutual fund investing would have suggested that the October 1987 crash was impossible; yet the flash-crash of 2008 still occurred.

The Improbable Happens

For example, Mark Rubenstein, a professor at University of California at Berkeley, noted that if annualized stock market volatility was assumed to be approximately 20% “(the historical average since 1928), the probability that the stock market could fall 29% in a single day is 10–160. So improbable is such an event that it would not be anticipated to occur even if the stock market were to last for 20 billion years. Indeed, such an event should not occur even if the stock market were to enjoy a rebirth for 20 billion years in each of 20 billion big bangs.”

Statistically Impossible

Although it was statistically impossible for it to happen, it did happen in 1987 and again 2008. The nature of crises is such that many will be unanticipated events with unexpected precipitators. As such, a medical endowment or physician’s portfolio contingency plan cannot address every conceivable event. What a contingency plan should address is the process for confronting these events. Most importantly, the plan should assign responsibility for actions and contain provisions to limit the ability of panic to impair long-term decisions.

Donor Trust is Core

Healthcare and all endowments have at their core donor trust. As such, it is important for an endowment’s contingency plan to include provisions for communicating promptly and forthrightly with the public. One only has to look at the Red Cross’ performance during the aftermath of the 9/11 tragedy to receive a lesson on an inappropriate approach. After donating more than $550 million to the Liberty Fund, donors learned that less than $175 million had been spent on direct aid for victims and that the Red Cross was allocating a large portion of the funds to other programs. After public outcry and congressional hearings, the Red Cross announced that all donations would be spent on direct victim relief.

Unfortunately, Dr. Bernadine Healy, the president of the Red Cross, resigned at least in part because of this controversy. These alleged violations of public confidence can have long-term impacts on an endowment’s donor base. Consider also the United Way whose national leader, William V. Aramony, was accused of fraud, embezzlement, and other charges in 1992. Even a decade later, inflation-adjusted contributions are lower than they were before the scandal even though charitable giving in general has doubled.

Assessment

The very nature of crises is such that pre-determined contingency plans generally allow more rapid and appropriate reaction. For an endowment, a well-considered contingency plan will include both an action (or standstill) plan and a public relations plan.

Note: Red Cross defends handling of September 11 donations on November 6, 2001: see: www.cnn.com

Conclusion

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Filed under: Investing, Portfolio Management, Retirement and Benefits | Tagged: Bernadine Healy, Mark Rubenstein, medical endowment funds, Red Cross, Stock Market Volatility, United Way, William V. Aramony |