Benjamin Graham, the father of value investing and mentor to Warren Buffett, liked to refer to “Mr. Market” as having bipolar disorder. The stock market tends to behave much more like a human being than a financial instrument. The market can be euphoric one moment and despondent the next. John Keynes, the famous economist, described the market as often being driven by “animal spirits” which could frequently seem irrational.
Unfortunately for investors, when the market starts to act erratically, it can be quite stressful. It causes people to go through similar emotional swings. We feel great when the market is up and believe all is right with the world, and then the moment the market has a down day or two, to immediately thinking we are on the verge of economic collapse.
As of my writing this, the S&P 500 is officially in “correction” territory, which means a 10% pull back from the most recent high. During these times it is beneficial to readdress some very common investing myths that will start to creep into our thoughts and emotions, potentially pushing us to make a poor decision. Below are two of the most common I see:
Myth #1: Volatility is not normal. If markets are moving something is wrong.
The truth is that volatility is extremely normal. In fact, without it, the expected return of stocks would be the same as cash. Human brains are not wired to process how much volatility the market demonstrates every year. Take this as an example: Since 1926, the S&P 500 has averaged around 10% a year for 92 years. If you were to guess how many years the market was within plus or minus 2% of the average (between 12% or 8%), what would you say? Take a moment and pick an answer.
Would it shock you to learn that only 6 years in the past 92 years of return for the S&P 500 were between 12% and 8%?
That is a remarkable statistic. It even surprised me. While it can be very stressful to experience market volatility in the moment, it is completely normal. Maintaining discipline and a long-term view has historically paid off handsomely for those investors that can stay invested through the volatility.
Myth #2: Investors can get out of the market to limit downside and get back in to participate in the upside.
The truth is that risk and return are related. The above myth implies we can get all the return with none of the risk. If it sounds too good to be true, it is. Like any get quick rich scheme, it is very appealing to the ears, but deep down you know it can’t be that easy. Anything worth doing takes time, work and discipline. Timing the market is nothing more than a fad diet. I read an interview with a nutritionist recently in which she said, “Telling people to eat more vegetables doesn’t sell books.” Enduring market volatility is the equivalent of eating our vegetables. Of course, we would all like to eat all the bread we want and not exercise and still be healthy, but that is not reality, no matter how many best-selling books are written about the next “easy” health trend. Likewise, no matter how many talking heads on MSNBC tell you of the next sure-bet stock or the perfect signal of when to get out of the market, none of it is true. Staying invested through market volatility is part of what disciplined investors do. It is the hard work that is required to capture the return of capitalism and the stock market.