This is the third article in a series that will discuss basic investment concepts in hopefully and understandable and meaningful way. Whether you work with an investment advisor or choose to do your own investing, there are some things you need to know to be successful. Here is my take on what those things are.
The stock market has cycles. The long term direction of the market has been northeast. There is one thing that is responsible for making the stock market higher over time. If the earnings of a company increase over time, the value of that company does as well. That is really all that you have to know to be a long term investor in the stock market. If you owned the S&P 500 (and you easily can) then there is a pretty good chance that the earnings of most of those companies have and will continue to grow. There is a website called PoliticalCalculations.com. Go there and look for a section entitled the S&P 500 at your fingertips. Enter your date of birth and you will see the growth of earnings and the growth of the value of the S&P 500 over your lifetime. I think you will be pleasantly surprised, and comforted.
The ups and downs of short term market cycles can be exciting or terrifying, depending upon the direction. The longest downturn since 1949 was 30 months (8/31/00 – 2/28/03). It seemed like forever. The average downturn since 1949 has been about 18 months. The lows of the U.S. stock market (bear markets) have always been followed by high (bull market). The most recent low was higher than the previous low and the next high was higher than the previous high. Imagine a man going up an escalator flipping a yoyo up and down. If you just watch the yoyo go up and down you will never see the big picture. A long term stock market chart goes northeast, but never in a straight line.
Volatility is your friend! Volatility is defined as the upward and downward movement of the price of a stock (or many stocks if we are talking about the stock market). But here’s the thing … volatility is not a loss unless you make it so. Pretend you buy a stock at $10.00 a share and a month later is at $7.00. It is down 30% in value. Whoa! If you sell it, you just had a 30% loss. If you hold it, and the stock went from $7.00 to $15.00 in the next year, you had a temporary downward fluctuation in the value of your stock, not a loss. I am not playing with words here!
People who do not understand this sell at the bottom of a fluctuation and buy back in at the top of a fluctuation. Selling low and buying high is financial suicide. Heaven forbid you buy when times are scary and get some good stocks at great prices. Stocks make you money over the long run because they are volatile. Volatility comes with the deal. Embrace it. When those other folks are in panic and selling their stocks in a scary financial time, think about taking buying those stocks at depressed prices. That is the right thing to do, but will take some courage and faith in the future.
We always have volatility! J. P. Morgan publishes their ‘Guide to the Markets’ every year. You can get it online. It has many, many useful pieces of financial information. One of their charts is called “Annual returns and intra-year declines”. Through November 2016 there have been 27 positive years in the stock market out of the last 37 years. That is a batting average of 750%. Well, during all of those 36 years there was an average intra-year drop (temporary downward fluctuation) of 14.2%. Whoa! In 2013 the market was up 13% for the year. But there was a time in that year when it went down 16%. If you closed your eyes on January 1st of that year and opened them on December 31st, you were up 10%. If you didn’t close your eyes and panicked when it when down 16%, you lose.
Michael J. McNamara Ph.D., CFP®
CERTIFIED FINANCIAL PLANNER™
*Any financial advice in this article is intended to be generic in nature. Readers should consult with their own financial advisors before implementing any advice or suggestions above.