The Stock Market Heart Beat – Something to Fear?

Do big gyrations in the stock market bother you? Is it painful to see a portion of your life’s savings evaporate over just a few short days? Most people would say “yes!” to those two questions. Would you like to see a world where you could never lose money in the stock market? Corrections, panics, crashes and market crises would be a thing of the past. Stocks could only go up. We can assure you that a one way street in the stock market would be the worst possible thing for investors.

Market volatility is a sign of healthy functioning markets

Picture a world in which stock prices never went down. Stocks would become risk-free, meaning that if you could never lose money the risk disappears. But sadly, when something becomes risk-free, it also offers low potential returns. Think about the returns offered today on checking and savings accounts, Certificates of Deposit and Treasury bonds. All of these are largely risk-free and their returns are also very low.

What would be the point of owning stocks if they had no downside and no upside? People would decide that investing in stocks was a waste of time. You might as well just stay in cash. Eventually the weight of this reality would set in and stocks would eventually fall no matter what you did to guarantee against it (think of the Chinese government trying to stabilize its stock market this year).

Back to the real world: It is the very volatility that most investors want to avoid that creates the opportunity for future returns that the same investors seek. Lower prices today are exactly what set things up for higher returns in the future. You can’t have one without the other. Market volatility is a sign of healthy functioning markets.  It shows that risk still exists. And without risk, there is no attractive return.

So we might as well learn to tolerate or even embrace volatile markets. How can investors learn to embrace volatility? We offer four thoughts:

  1. Understand that risk and volatility are a sign of a healthy functioning market.  A market with a flat-line heart beat is not a healthy functioning market.
  2. Take advantage of the market’s drops to increase your share of the global economic pie.  The value of that pie will fluctuate, but if you can increase your share over time, you will be using the market’s gyrations to your advantage.
  3. If you need money from your investment portfolio, sell well before you actually need to spend the money. To do otherwise is just inviting a bad outcome.
  4. If you are spending only a portion of your savings and investments each year, then recognize that it doesn’t matter what stock prices are today.  It only matters when you go to sell.  Were you planning on selling your stocks last week?  If not, last week’s ups and downs should not bother you if you have enough cash on hand so that you won’t be a forced seller.  If you don’t need the money today why would the actions of others dictate your actions?

The only reason that stocks can go up is because they can also go down. Long-term investors should rejoice when fear is reintroduced into the markets. The heart beat of the markets tells us that it’s alive and functioning well!

Important Note: These materials are provided for informational purposes only.  Please do not assume that any information contained in this Insight serves as the receipt of, or as a substitute for, personalized investment advice from Madison.