Gil’s Musings

5 Maxims for Weathering Volatile Markets

In the past few months, we’ve seen the sort of market volatility that can leave investors feeling disoriented and frustrated. In times like these, it’s important to keep some perspective and avoid making emotional decisions. Here are five things to keep in mind:

1) In the history of the U.S. stock market, winning years outnumber losing years by two to one. In the past hundred years, the market declined more than 30% in only three of them. During that same period, the market has had 26 years in which it gained 30% or more, and five in which the gains exceeded 50%. By comparison, there’s never been a year that the market has fallen by 50%. Warren Buffett likes to say that “bull markets take the escalator and bear markets take the elevator.” While the speed and intensity of recent declines may make investors uneasy, it’s important to remember that the “building” has gotten higher. In other words, every time the bear market takes the elevator, it’s taking it from a higher floor.

2) Selling stocks to avoid a market downturn invites costly consequences in the form of taxes and the loss of deferred gains. Reinvesting is tricky, it’s often poorly executed, and investors rarely benefit from it. When you factor in commissions, the odds of coming out ahead erode even more. But that’s not all. Short-term gains can be taxed at rate of as much as 43.8%, and losses of any type are only marginally deductible against income. You can find yourself playing a game with the Internal Revenue Service that feels a lot like “heads they win, tails you lose.” But holding stocks for a profit over a lifetime results in the forgiveness of capital gains taxes at death. Clearly, weathering the downturns by holding stocks as long as possible has its advantages.

3) Purchasing stocks as part of a fixed routine makes declining prices work to your advantage. Not only is this strategy a winner psychologically, the math works, too. Setting a specific dollar amount with which to buy stocks each month means that you will always pay less than the average price during the year. Why? Because you get more shares when prices are low and fewer shares when prices are high.

4) Understand the difference between investing and speculation. A speculator wagers that another investor will pay more later. In other words, they’re simply betting that a stock’s price will rise. When the price falls, panic sets in because they have no fundamental reason to justify owning the stock other than the price. An investor, on the other hand, anticipates that an investment will pay for itself with cash flows – the price is irrelevant. It’s a little like a rental house or a company with a great business advantage that pays a dividend. Who cares what the price is right now?

5) Embrace ambivalence. This may sound counter-intuitive, but ambivalence can be the most important emotion for the successful investor. During more than 30 years of investing and observing other investors, I’ve seen smart bets and stupid ones. I’ve seen surprises resulting in profits and losses. I’ve seen whiny investors and brave ones. But ambivalence is the one characteristic that is important to making money over time rather than simply achieving the best results right now. Some investors can weather volatile markets without worrying, and others can’t, but those who can are almost certain to double their return — market up, market down, they don’t care. Of course, it’s easier for investors with more assets to be more disinterested, which creates a challenge for aspiring investors: to build enough assets to be disinterested in the market’s daily gyrations, you have to train yourself to be disinterested in the market’s gyrations. Hard to do? Psychologically, perhaps, but not if you look at the market trends. In the history of the market, there’s never been a 10-year period that produced a negative return, and most declines result in a new high within five years.

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