Volatility, Leverage, and Emotion

After a strong year of performance in 2025, across stocks, bonds, and gold, global markets have begun to exhibit higher realized volatility. While this is not unusual following periods of strong returns, it can feel unsettling when prices begin to move more sharply and unpredictably.

The Emotional Dimension of Volatility

From a portfolio-management perspective, rising volatility has the potential to trigger negative emotional responses. This is a well-documented dynamic. Market stress rarely occurs in isolation; it often coincides with other pressures in an investor’s life; work, family, health, or major transitions. When multiple stressors converge, even disciplined investors can feel overwhelmed, despite having an intuitive understanding that volatility was always a possibility.

This is where a trusted advisor can play a meaningful role. Consider using your advisor as a sounding board, an outlet to process concerns, pressure-test assumptions, and regain perspective. One of the primary ways an advisor adds value is by helping clients remain consistent during turbulent periods. There is strong evidence that a well-designed investment strategy, paired with disciplined execution through time, tends to produce attractive long-term results.

Stepping Away From Emotion: How Market Structure Creates Volatility

Beyond psychology, there are mechanical features of markets that help explain why volatility tends to appear in bursts rather than in a smooth, linear fashion.

CRB Strategic Services clients have often been encouraged to strengthen their household balance sheets by reducing liabilities. The logic is straightforward: investment capital is deployed within a highly leveraged global financial system. By reducing personal debt, households improve cash flow and reduce sequence-of-returns risk; particularly important during the distribution or retirement phase of investing.

While CRBSS clients do not use leverage to obtain market exposure, many other market participants do. Professional investors frequently employ leverage and manage that added risk using systematic models that dictate when leverage should be reduced. “Taking down leverage” is a technical way of saying selling market exposure. Importantly, volatility itself is a key input in many of these risk-management frameworks.

Reflexivity: When Selling Creates More Selling

This dynamic helps explain why volatility and selling often reinforce one another. Rising volatility can trigger forced or model-driven selling, which in turn creates more volatility, forming a self-reinforcing feedback loop. These cycles can persist until interrupted by some form of policy response, such as interest-rate cuts, quantitative easing, or fiscal stimulus.

There is no reliable way to predict how deep or prolonged such feedback loops may become, because their severity is ultimately driven by investor behavior rather than fundamentals alone.

Portfolio Tools That Matter Most

Two timeless portfolio disciplines become especially important in these environments: diversification and rebalancing.

In 2022, we observed a breakdown in diversification benefits as stocks and bonds, particularly corporate bonds, became highly correlated and declined simultaneously. This experience reinforced the value of incorporating assets with genuinely different return drivers.

Asset classes such as commodities and trend-following strategies, when thoughtfully integrated into a diversified portfolio, provided sources of liquidity during that period. Those return streams could be sold to meet household expenses or redeployed through rebalancing, allowing investors to buy equity shares at more attractive, depressed prices.

The Psychological Advantage of Diversification

The benefits of negative or low correlation extend beyond portfolio mathematics. A smoother overall return profile can significantly reduce the psychological cost of living through volatility. When portfolios behave more resiliently, investors are more likely to stay disciplined—greatly improving the odds of achieving long-term financial goals.

Thank you for taking the time to read this post. Please feel free to reach out with questions or thoughts—I’m always happy to discuss how these dynamics relate to your own financial plan.