Volatility - A word on many investors' lips in recent times. Some might hear it and immediately go into a state of nervousness, while others may hear it and think of opportunity. The truth is that volatility is still ambiguous to most investors. In today's article, we break down how volatile the markets truly are and an approach to tackle this problem head-on.
The Reality of Being Invested In The Markets
Benjamin Graham once said that Mr. Market suffers from bipolar disorder. Mr Market is, of course, a pseudonym for the stock market. The stock market fluctuates between overvaluation and undervaluation depending on whether Mr Market is feeling optimistic or pessimistic like a pendulum on an old clock. Yet those swings do not happen like clockwork, and an inordinate amount of time is wasted attempting to predict such things.
Wondering whether there is going to be a market pullback is an odd proposition - of course stocks will pull back. Since 1928, the S&P 500 has declined 10% or more from a recent high more than 90 times, or about once every 11 months, with just a handful of years not recording a 10% dip. Ten-percent pullbacks are almost as common as summers, yet nobody ponders whether summer will come around again this year.
Eleven to twenty-percent market drops have occurred 31 times since 1928, or about an average every four years. Thirty-percent market drops have occurred about an average every ten years, and forty-percent declines happen a few times per lifetime. In Australia, the figures are within the same ballpark, albeit a little less volatile in the last 35 years.
Few of us are immune to the emotional delusion that the market won’t crash from time to time and panic when it does. The number of investors who claim to be contrarians outnumbers actual contrarians by orders of magnitude, so it’s common for the majority to react fearfully when volatility (i.e. a drawdown, because nobody really talks about volatility when stocks are rising) occurs, despite the inevitability.
Before considering any road map for opportunity volatility can present, it’s crucial to have the mindset that allows successful investors to stay in the game by accepting it as the price of admission and learning to respond rather than react when it occurs.
The Two Ways to View Market Volatility
The price of admission to Disney World is long lines, crowds of people, sore feet from all the walking, subpar food and exorbitant prices that have been ahead of inflation for decades.
The trade-off for all of that is creating wonderful memories with your family, a handful of good roller coasters, ear-to-ear smiles for your kids and a family photo or 20 you can fondly look back on for a lifetime.
The price of admission to the stock market is gut-wrenching volatility, a lumpy return stream along with the pain brought about when you see a chunk of your life savings evaporate before your eyes. The reward inside is long-term returns above the rate of inflation, compounding that can earn investors multiples of the initial investment and the greatest wealth-building machine ever created.
This is the nature of the beast. The mindset hack to investing is overcoming the emotion of paying the fee of volatility every so often. Everything nice has a price and long-term compounding is no free lunch.
Of course, it’s not so easy as to flick a switch to becoming an emotionally inverse investing machine like Warren Buffett. Even though you may accept volatility is inherent, emotions can kick in when you see headlines about billions being wiped from the market in a single session.
Weathering the Ride of Market Volatility
Feeling uncertain every time the market flirts with the bear territory is reasonable. What you do next is the difference between harnessing the power of compounding and making errors that erode wealth. It is the choice between responding and reacting.
Responding, a spin-off from the word responsibility is considerate and deliberate. Reacting, on the other hand, literally means to meet one action with another one. It is immediate and rash.
Reactions tend to go like this: Something happens. You panic. Then you proceed.
Responses tend to go like this: You Plan. Something happens. You Pause. You Process. Then you proceed (with your plan).
Responding is harder than reacting. It takes more time and effort. It often requires letting a strong itch—the yearning to immediately do something, anything, about whatever just happened—be there without scratching it. But, like most things that require effort, responding also tends to be advantageous. You rarely regret deliberately responding to a challenging situation. You often regret automatically reacting to one.
One way to help this is to have a written investment plan which includes your personalised approach to responding to volatility. Winston Churchill once said, “Let our advance worrying become advanced thinking and planning.”
Building interventions to protect yourself from yourself could be more beneficial than trying to time the market or unearth some rare 100-bagger. Overall, history shows that following a simple investment strategy and staying the course through market volatility frequently results in the best long-term returns.
Markets & Commentary
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.