Why Volatility Is Our Friend

In the beginning of October, the Dow experienced over a 1,000-point loss in the matter of two days. Nothing creates more fear in investors than watching the stock market dip or tumble. After all, you have your hard-earned money at stake, and watching it dwindle can create a slew of emotions. Still, it’s important not to let these feelings run rampant.

Behavioral economics researchers, who study our emotional connection with money, have discovered that losing money feels twice as bad as making money feels good. So, these negative feelings with dips are much more powerful than positive emotions of growth.

It’s no wonder then that when the economy experiences volatility, many investors want to head for the proverbial hills. But this is not a long-term strategy for investing.

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Volatility can prevent great rewards for investors who step in and out of the market. It’s critical to understand, however, that volatility is our friend. It’s our friend because it’s necessary.

What I want to do is create a new way for you, the investor, to look at volatility.

Sure, the risk and uncertainty that are ingredients in the “V-word” are unsettling at best. But they are part of investing in the stock market. It’s a risky endeavor, but time in the market beats timing the market almost all the time.

Here’s what we know from the past 100 years. From 1919 to 2019, the S&P 500 (with dividends reinvested) has averaged a 10.1% return per year. For comparison, bonds, in particular 10-year government bonds, today yield about 1.5%. Over time, they have averaged 5%. So, we’re looking at 10% in the stock market versus only 5% in bonds.

Let’s talk about the “Rule of 72.” This rule is intended to calculate how long it will take an investment to double given an annual rate of return. If we apply our averaged 10% rate of return to the Rule of 72, our stock market investments will double our money every 7.2 years. That’s good news, folks. And the numbers don’t lie.

According to other data on the behavioral effects on investors’ returns over a 20-year annualized basis (from 1999 to 2018), the average investor is netting a mere 1.9% on his investments.

Why? Because when the stock market experiences natural volatility, these folks jump out. Then, when things appear to be back on the upswing, these investors buy back in. What they’re doing, in essence, is selling low and buying high. This behavior doesn’t make for a desirable long-term rate of return.

Compare this data point to the annualized return of various investment vehicles over the same period. Real estate investment trusts (REITs) have averaged 9.9%, gold was at 7.7%, oil at 7.0%, and the S&P 500 averaged 5.6%. These rates of return are miles away from the 1.9% garnered by the average investor in the same 1999 to 2018 study.

To get to that juicy place of higher returns, you have to ride out the currents of stock market volatility. This entails facing uncertainty with a steadfast, stick-to-it approach. After all, you want to make good with the Rule of 72. You can’t do that by sticking your money under your mattress or hopping in and out of various asset classes!

Meanwhile, stock investors who have stayed the course have enjoyed a return premium. And for that premium, of course, there was a price. There aren’t any free lunches in America, folks. That premium is bought by staying in the market with at least a portion of your assets, and understanding that investing is a marathon, not a sprint.

This premium that these investors receive is based on their willingness to battle through the inevitable uncertainty of markets. Sure, they experience periods of emotional stress, but they don’t let fear and worry drive their investment strategy. They stomach change and roll with the punches. It’s this difference that shakes out the uncertain and timid from the lot that has more grit for stock market volatility.

These resilient investors understand that volatility is necessary – it’s an essential gateway for an asset class to deliver value over the long haul.

Investors who see temporary declines as permanent are not seeing beyond these short-term dislocations. It’s a commitment to stocks that produce the long-term return, not a brief love affair. This is the difference between the market’s 10.1% long-term average and the 1.9% of the average investor.

But with this understanding, and an embracing of volatility come freedom. Volatility, over time, can prove to be our friend and allows us to be better investors. Greater uncertainty has led to greater returns for the past century.

In times like these, when trade wars and political wars make the economy seem like it is skating on thin ice, this is a critical point to remember. Volatility is simply part of the fabric of the tapestry of a committed investment plan. It’s necessary to win out over time as investors in the businesses of the United States. My advice is don’t fight it — embrace it.

Read original AJC article here


This information is provided to you as a resource for informational purposes only and should not be viewed as investment advice or recommendations. Investing involves risk, including the possible loss of principal. There is no guarantee offered that investment return, yield, or performance will be achieved. There will be periods of performance fluctuations, including periods of negative returns. Past performance is not indicative of future results when considering any investment vehicle. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment adviser before making any investment/tax/estate/financial planning considerations or decisions.