That darn stock market has been all over the place lately. Is it time to ‘de-risk’ your portfolio? Is staying in worth it? Well, let’s take a step back and gain some perspective. Everything that we want has a cost either in time or money. If we want to take the kids/grandkids to the zoo, there is a cost of admission, but we view this as a
worthwhile tradeoff because of the good time that we expect.
The same principle applies to investing in the stock market. The whipsaw of day-to-day
volatility is the cost for expected returns. The problem is, we tend to think of this cost as some type of penalty or assessment without simultaneously thinking about the future returns. In our mind volatility is only bad without any good.
It’s a Zoo Out There
In our example of visiting the zoo above, you can’t see the sea lions, exotic birds, and giraffe’s unless you are willing to pay the price of admission. You can stay home and not pay anything of course, but the tradeoff is you won’t have the experience of being at the zoo.
As an investor, you can choose to avoid paying the cost of admission to the stock market and instead be satisfied with whatever interest can be earned on bank CD’s or similar cash-oriented instruments. What you can’t avoid, however, is the
constant erosion of your purchasing power by way of
inflation.
Carrying on with our example of going to the zoo, if you decide it is worth paying the cost, you also have to acknowledge that the weather might be poor on the day you attend. There’s nothing you can do about the rain or the heat or cold. You understand that’s a risk worth taking for the possible benefit you are likely to receive. You simply can’t control the weather on any particular day.
Disjointed Preferences
When it comes to the stock market, I believe the behavioral preference known as
anchoring is responsible for most of the gnashing of teeth about volatility. Whenever a client brings up volatility as a concern, it is prefaced with how much the market has ‘gone down’ in the preceding week or month. That is, the measurement timeframe for decline is from a very specific temporary high mark one week or one month ago. But that particular value, even if it is the end of a year, is just a transitory value and surely to change the next day. We can’t lose something that we never had in the first place.
When it comes to the stock market, the most reliable way to obtain long-term market returns is to stay in the market at all times because the underlying reason for investing (increases in inflation) also rises permanently. Since 1960, the Consumer Price Index (CPI) has increased about 9 times; The S&P 500 Index has risen about 50 times during the same time. Along the way there were 12 negative return calendar years (out of 59). Is it worth it? Only you can decide. Start there.
Related:
Explaining Media Explanations on Financial Market Activity
