If you’ve been following the news, you may have noticed that U.S. stocks are off to a bumpy start this year. For the most part, investors enjoyed a smooth ride in 2021. Unprecedented stimulus measures from both the Federal Reserve and Congress helped boost markets despite ongoing pandemic concerns. Now, uncertainties like inflation, rising interest rates, and a potential Russia/Ukraine crisis are spooking financial markets. Market volatility can be unsettling, and many investors are wondering if there’s danger ahead.
Investors are naturally biased towards action, making it difficult to do nothing when markets are shaky. Yet panicking and deviating from your long-term investment plan typically yields worse results than staying the course—even when it feels scary to do so.
The truth is, we don’t know with certainty what lies ahead for investors. What we do know is that equity markets tend to rise more than they fall over time. And historically, long-term investors have been rewarded for their patience. There’s no reason to believe that this time is different.
If you’re nervous about the stock market, consider the following investing principles to keep volatility in perspective:
#1: This Time Isn’t Different
The world is constantly changing, and there are always new reasons to worry. But that doesn’t necessarily mean that “this time is different.” In fact, when it comes to the U.S. stock market, history tends to repeat itself time and again.
In 2020, I wrote a blog article entitled, “Time After Time: Stock Market Crashes and The Media.” The theme of the article was that the financial media never wastes a good crisis. A historical look at the biggest headlines during any market downturn would have you believe that the world is ending, and investors are doomed.
Of course, we all know that bad news sells. What doesn’t sell newspapers? Stories of calm and recovery. Yet so far, the U.S. stock market has always recovered its losses—and then some. The following image from Visual Capitalist perfectly illustrates this point.
If you zoom in on one section of the chart—for example, 2008—it certainly looks like the S&P 500 Index took a terminal nosedive. However, when you consider it in context, the global financial crisis was merely a blip, frightening as it was.
The point is this time probably isn’t different. Volatility isn’t new. We’ve all experienced it before to varying degrees. And if history is a guide, long-term investors will be rewarded for sticking it out.
#2: Volatility Creates New Investment Opportunities
“Buy low, sell high” has long been the siren song of ambitious investors. Or as Warren Buffett famously said, “Be fearful when others are greedy and greedy when others are fearful.”
Unfortunately, investors tend to do just the opposite, selling into panic and buying into euphoria. In other words, we let our emotions cloud our rationality. Dalbar’s annual Quantitative Analysis of Investor Behavior report continually proves this point. The average investor not only underperforms the market—they also underperform their own investments due to poorly timed decisions.
The good news is if you can come around to the idea that volatility is normal, you can start to view it as an opportunity rather than something to fear. Market corrections and downturns provide opportunites to buy stocks at a discount, thus allowing more room for appreciation when the market eventually recovers.
Leveraging these opportunities can actually boost your overall investment results over time. On the other hand, going to cash when the market is down can undo years of progress towards your financial goals.
#3: Volatility Is the Cost of Earning a Higher Rate of Return Over Time
There isn’t a simple reason why stocks are an inherently volatile asset class. However, there are a multitude of stock market participants with competing motivations and expectations. Considering that many of these investors are emotional beings, it isn’t surprising that stock prices can be turbulent from time to time.
On the plus side, equity investors are typically rewarded for enduring these inevitable periods of volatility—at least historically. Finance professionals refer to this concept as the equity risk premium. Investors can expect to earn a higher rate of return on stocks over time to compensate them for taking on higher levels of risk.
Consider that the average annualized return of the S&P 500 Index since its inception in 1926 through the end of 2021 is 10.5%. That number includes every correction and bear market since the index’s inception. In other words, volatility may be an ever-present force, but the equity risk premium endures. It’s this trade-off that allows equity investors to outpace inflation and grow their wealth to reach future financial goals like a comfortable retirement.
Bottom Line: When Volatility Spikes, Don’t Panic. Do This Instead:
Over my 20 years as a financial advisor, I’ve had countless conversations about market volatility with clients and colleagues. The circumstances may change, but the message remains the same: don’t panic. One of the worst things you can do is abandon your investment plan due to short-term discomfort.
A better solution is to work with a trusted advisor to develop a long-term investment strategy that’s aligned with your goals, time horizon, and tolerance for risk. At Align Financial, for example, we also focus on diversification, ongoing risk management, and education to smooth the ride for our clients and help them avoid permanent capital loss.
Here are some additional tips for keeping volatility in perspective and sticking with your long-term investment plan:
- Don’t try to time the markets. Many investors don’t realize that market-timing means you have to get two decisions right—when to get out of the market, and when to get back in. Failing to get the second decision right is what can significantly erode your net worth over time.
- Avoid checking your account balances frequently. Studies show that looking at your investments too often can lead to excess trading and lower investment returns over time. Try to check in no more than once per month, or better yet quarterly.
- Turn off the news. The media is incentivized to sensationalize current events. The media also doesn’t care if you can afford to send your kids to college or retire when you want. To achieve your financial goals, ignore the noise and focus on what you can control instead.
Align Financial is passionate about helping our clients make smart decisions for a financially successful future. If we can help you align your money with the life you want, we hope you’ll contact us to see if we’re a good fit.