Here We Go Again – Risk is Your Friend

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There’s a good reason several musicians have songs titled “Here we go again” …life is full of challenges that cycle through. However, people living full lives rarely give up easily.

In other words, anything worth doing has some risk. Driving, love, business, raising children, investing, traveling, even crossing the street. Tree branches that fall during a storm can create delays and detours but improve the long-term health of the tree. Similarly, markets have to go down sometimes to be healthy in the long-term.

For example, half of all years since 1950 have experienced double-digit stock market drops, while the stock market’s average annual return (as measured by the S&P 500) since 1950 was about 11%. Accepting the volatility of the stock market is necessary for long-term success. The “no pain, no gain” rule applies to investing too.

Why must markets drop occasionally? The absence of a crystal ball leads to imperfect information (i.e. uncertainty) and therefore fear. Too much fear, and prices overshoot on the downside. Not enough fear (i.e. overconfidence), and prices overshoot upwards. Over time, the level of fear averages out and roughly reflects the natural positive long-term growth of economies.

Fear is an important check-and-balance mechanism, and successful long-term investors welcome a bit of fear in the market, because they view it as proof that they will receive a reward for taking risk over time. Also, one person’s panic selling becomes another person’s opportunity to hold and buy stocks on sale, also known as rebalancing. No downside = no upside. It’s that simple.

Where money is really made is in the bad markets, by being disciplined and avoiding panic. Getting out stocks when they are down locks in losses and misses the recovery. Sadly, those that view volatility as the only or biggest risk, and try to avoid it by holding cash as a “no risk” alternative, subject themselves to a silent but larger risk that has no reward in the long-run: damaged purchasing power through returns lower than inflation.

As a result, the better question is not “how can you avoid market volatility” but rather, “are your risks controlled and appropriate, and are you properly benefitting from market volatility.” Seeing market fluctuations as a valuable recurrence, and applying a proven process of diversification and rebalancing, is key to long-term results… and peace of mind.

So, here we go again!

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