If there is one constant when it comes to equity investing, it is volatility. Experienced investors know all too well that over the course of their investing career, they will see numerous declines in the value of their holdings. Some of the declines will be modest, drawing scant notice, but others will test investors’ convictions to well-designed, long-term investment strategies. Knowing it will happen is one thing, but experiencing it is another. Yet, it is volatility that creates the excess returns known as the equity risk premium. Uncertainty creates volatility and volatility creates opportunity. Absent volatility, stocks would produce the same sub-par returns as stable assets like Treasury bills, bank CDs, and money market accounts.
The stock market is a collection of world-class companies whose shares are publicly traded and available for purchase by anyone with a few dollars to spare. Choices abound, from Amazon to Apple, Merck to Microsoft, Walgreens to Walmart, and thousands of others. The S&P 500, a collection of the largest companies, falls in value at some point between January 1 and December 31 every year, without exception. The average annual intra-year decline is about 15%, some years more, some less. Yet the equity market still generates positive returns the vast majority of time. That’s because companies grow along with our economy which is growing the vast majority of time, pausing occasionally to catch its breath before growing again.
If you want the long-term returns expected from owning companies, then you must accept their inherent short-term volatility. You cannot have one without the other. While not easy to do, successful investors embrace volatility, knowing that market declines create opportunities to buy additional shares in world-class companies at a discount. Failed investors do not understand this. They buy when stocks are trading at premium valuations and sell when they fall in price, often at the points of greatest opportunity. Which type of investor will you be when these inevitable declines occur?
Stay Committed.