My daughter Kathryn recently moved out to Berkeley CA to continue her schooling at the University of California @ Berkeley. Within the first few days after her arrival, the San Francisco area was hit by a small earthquake. As she grew up on the East Coast and was unfamiliar with any earthquakes (whether they were small or large), she was agitated and worried. She wondered: Was this the beginning of a major earthquake?
I tell this story to discuss how new investors in the stock market often view the swings in prices that occur on an hourly, daily and weekly basis. If they are not aware that there will be frequent movements in stock prices, they may experience the worry and agitation that my daughter felt the first time the earth under her began to move.
The key to overcome this nervousness is to understand and appreciate that the movements for both are commonplace and expected. The key difference with the stock market is that the long-term historical performance is one of temporary declines and permanent increases in the overall stock prices. We have written often that the stock market has been the greatest creation of wealth the world has ever seen. However, the short-term temporary stock market declines at times are severe; and far too often, investors’ mistake these small tremors for the end of the world.
Years ago during the “great recession” at the beginning of 2009, a visitor to my office viewed the chart on my wall showing the long-term gains from large company stocks, small company stocks, bonds and cash and questioned,
So the stock market value is not going to go to zero?
Not if history is any guide. When viewing stock market performance over the time horizon the most people will need to be invested – 40 or 50 years – it’s hard to see many of the market declines. All you really see on the chart is the great advance. Explore three part series that views the U.S. stock market performance from 1975 to 2013 here: A Tale of Four Decades
(A side note: Often financial advisors use the word stock market volatility to describe these ordinary stock movements. Try to avoid the word volatility because if you look up the word ‘volatility’ in the Encarta Dictionary, the word has the following definition: unstable and potentially dangerous; apt to become suddenly violent or dangerous. Synonyms include unpredictable and unstable. And we wonder why investors get nervous.)
To complete the analogy with earthquakes, after there has been a large earthquake in an area, for many years following the event each small tremor brings back memories of the terrible earthquake. I believe it’ll be many years for investors to “let go” of the 2008/2009 stock market decline. Many “investors” sold at stock prices that will never be seen again because they were so low.
Weston Wellington of our partner Dimensional (DFA) has commented:
Contrary to the beliefs of some investors, dramatic changes in security prices are not a sign that the financial system is broken but rather what we would expect to see if markets are working properly. The world is an uncertain place. The role of securities markets is to reflect new developments— both positive and negative—in security prices as quickly as possible. Investors who accept dramatic price fluctuations as a characteristic of liquid markets may have a distinct advantage over those who are easily frightened or confused by day-to-day events and are more likely to achieve long-run investing success.
These memories influence decisions as temporary market declines occur again. Hopefully they have a behavioral advisor who will keep them focused on the long-term historical perspective of the stock markets so that they can earn the stock market premium that has historically been given.
Give us a call so that we can help you gain this perspective.
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