The Informed Investor
Important Lessons Learned From Market Volatility
June 27, 2022
This letter represents some of the important lessons learned and the valuable mindset useful to enduring times like this to achieve and maintain sustainable wealth. Watching financial markets continue rising with minimal volatility will not test investors’ patience but maintaining discipline through turbulent markets like these can be difficult for many. After a prolonged bull market in both stocks and bonds that extended over 12 years, all investors are now witnessing a sharp reversal in direction. This time is more challenging than most because the expected diversification benefits from high credit quality bonds to help cushion falling stock prices do not apply when the threat of inflation is present. Although bonds have also recently dropped, solvent issuers pay timely interest as well as repay one hundred cents on the dollar (par value) of investors’ capital when bonds mature.
Those not new to investing have hopefully learned much, some from lessons learned the hard way. Errors in judgement related to investment decisions, most often made during times of stretched emotions, can prove extremely costly, sometimes with life-changing consequences. While nobody should expect to make only perfect investment-related decisions, we can improve the outcomes of our choices by learning from the mistakes of others in addition to our own. One example an astute investor constantly asks is, “Am I maintaining a calm and balanced perspective?” If not, he or she recognizes that they are more prone to interpret circumstances in a way that influences near-term decisions they will regret later. Unless a person is superhuman, the desire to make more money (Fear Of Missing Out or “FOMO”) influences their decisions. At other times, the instinct is to preserve remaining capital when markets uncomfortably fall (Fear, Uncertainty, and Doubt or “FUD”). During these conditions, it is all too easy to let other people’s behavior and thoughts affect ours. Friends, family, news media, public sentiment, and even our own prior experiences are shaping our views today, and more importantly, the outcomes of our decisions. While much of the information we gather has some element of truth, to what extent are we willing to broaden and deepen our perspective by exploring contrary informed opinions? Or are we primarily relying on information that reinforces our conviction? Acknowledging our degree of awareness regarding these influences can go a long way to improving our decision making.
Some investors are comfortable investing in volatile financial assets only when price swings are trending upward. Well-diversified stock and bond portfolios have risen 80% of the years since 1926. History has proven that 80% is more than enough to generate considerable wealth when investing properly. During the other 20% of the time, some declines have been modest while other periods have been more worrisome. It is the less frequent faster or prolonged larger declines that often cause many investors discontent. Stock market declines of 20% or more, like this year, occur every three years on average. So what should an investor do during tougher financial market environments? There are only two choices. An investor can buy and hold for the long-term or jump in and out whenever he or she feels the market is about to reach a peak or after a decline has begun and is expected to worsen. Neither decision is perfect, but one alternative has proven to be far less rewarding than the other. The reason is that emotionally driven sellers consistently sell low, reacting to recent adverse circumstances and then rebuy at much higher prices after markets stabilize and regain their upward trend. Yes, it’s all too easy to jump on the band wagon and buy during the euphoria when financial markets are steaming ahead and jump off when markets are no longer cooperating. The problem with this choice? Investors should have learned through the overwhelming examples in the past that their profits were much smaller versus patient and disciplined investors.
What else can we learn from those investors that didn’t fare as well as they expected in navigating and tolerating difficult periods in order to gain or preserve longer-term wealth? They failed to embrace the following… financial success is most often attained by proactively establishing and maintaining an efficiently diversified and sufficiently comfortable investment strategy during both rising and falling markets. If an investor is too uncomfortable then they should revisit these criteria with their financial advisor. If still in doubt, ask yourself, “How often have I seen others disregard discipline and patience by overreacting to challenging circumstances that led to non-regrettable decisions?”
Financial markets have existed for thousands of years and are essential to global health and even our survival. Like many other facets in life, they are not intended to be perfect. Having the opportunity to enjoy financial prosperity 80% of the years during our lifetime should be more than adequate to enable and retain financial independence. Thank you for allowing me to share with you some of the valuable lessons learned with the intent that they may serve your interests too.
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