Learn to like volatility

3 years ago 0 546

How many songs have you heard that include lyrics like “Here we go again” or “It happened again” or “I did it again”? There are many, because trials and tribulations in life are many. The best outcomes happen, however, when you push on through.

You didn’t expect it all to be easy, life’s best elements involve some risk. Traveling, relationships, transportation, investing, the list is long. Nature prunes trees with storms and that can slow your trip, but it improves the health of the tree in the long-run, whereas top-heavy trees with no pruning are more likely to fall over entirely and die. That’s not unlike the stock market markets, which naturally rises and falls to remain healthy over the long-run.

Did you know that ½ of the years after 1950 saw 10%+ stock market falls? That, while the market’s average return (based on the S&P 500 index) since 1950 was around 11%. Those who accepted the volatility were rewarded in the long-run. The old adage of “no pain, no gain” is relevant for investing also.

But why do markets need to drop sometimes? Without a window to the future, there is uncertainty, and that causes fear. A bit of fear is healthy. If fear is too high, stock prices get pushed under their real value. Too little fear (i.e. too much confidence) and stock prices get overvalued. These effects average out over the years, and markets end up approximately reflecting a reasonable middle.

Sophisticated investors welcome the fear because it means the system is working. Also, when much of the world panics, experienced investors swoop in and buy more stock at bargain prices (otherwise known as rebalancing). To have upside, there must be downside… so be in the profit group, not the panic group.

The panic group loses more than they should by selling at the bottom and missing the recovery. Unfortunately, those who view volatility as the worst risk are fooling themselves. Going to cash may feel low risk, but brings on purchasing power risk (i.e. earning less than the inflation rate).

Ask not how you can avoid market volatility. Instead, ask if your risks are measured, controlled and reasonable… and whether or not you are sufficiently benefitting from market volatility in the long run. Seeing volatility as something that adds value over time, and using a proven process of portfolio diversification and rebalancing is the magic sauce for feeling more confident and calm, and therefore better long-term outcomes.