Investing Is About Playing The Long Game
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Why are people so jumpy?
That’s the question I am asking myself day after day lately.
At AMR, we consistently and constantly stress that stocks are long-term assets. I write it in letters, present it in webinars, and say it on the radio show.
We preach every day that stocks are volatile and a 20% drawdown in any given year should be expected.
As I write this on March 10, 2022, the S&P 500 is in an 11.06% drawdown that started on January 4, 2022. The drawdown is a little over half of what I would consider a normal drawdown and below the average annual drawdown of the S&P 500 (16.5%). In terms of time horizon, we are talking about a time frame that is extremely quick.
So, why are people so jumpy? I have theories.
First, people assume I am being hyperbolic when I talk about the scale of a potential drawdown. Most people consider a year to be a long time. The stock market had a run of about 21 months without a drawdown of note. The average person wrote off the quick one-month pandemic drawdown as an anomaly.
The reality is that one year is not a significant time in the stock market. Wealth is compounded over decades of reinvestment. A quick zoom out on performance shows that the S&P 500 is now currently in its fourth correction (decline of 10%) in five years. Drawdowns are normal and should be expected.
If you’re the type of investor that thinks a drawdown on that scale is hard to deal with, then diversify into other types of assets (primarily bonds). You might have some FOMO (fear of missing out) during a roaring bull market, but you’ll rest much easier during a sell off and you’ll have the ability to rebalance into cheaper stocks rather than run for the hills at the worst time.
Second, people assume that this situation is far more serious than prior events – “Have you seen what is going on in Ukraine?”
Like the rest of the world, I have seen and tracked very closely what is happening to Ukraine and the Ukrainian people. Unlike most of the rest of the world, I’ve looked back at capital market returns during some of the most trying times in world history.
Immediately following Pearl Harbor, the Dow Jones had a correction which ended four months later when the stock market bottomed and reversed course on a 4-year bull market run that nearly doubled the value of the index. Dividend yields for the index were also closer to 5%.
World War II gave way to the Korean war in the early 50s and 1950 through 1955 were some incredible years for the stock market. The price of the market grew 139% while dividend yields were even stronger, averaging 5.5%.
Source: Macrotrends
The Korean war gave way to the Vietnam war which lasted nearly 20 years. From the beginning of the war in 1955 to U.S. formal withdrawal in March of 1973, again, the S&P 500 nearly doubled. Dividend yields were lower at this point, but still better than 3%.
Geo-political nightmares have not kept the stock market down.
Third, people are concerned about inflation hurting their personal budgets and question whether they can deal with high gas and food prices while their portfolio is under pressure.
To me, this is the most reasonable of the three concerns. When we prepare a financial plan there are typically assumptions for inflation built into the analysis, but it certainly does not assume a number greater than 7% for an extended period!
The war in Ukraine and Russia could fundamentally alter your financial plan and your ability to take risks. You should re-evaluate your plan. That’s the bad news. As you might guess, I have some good news, too. The good news is that even during the worst bout of stagflation in the 1970s, there was positive total return for the decade. Stocks tend to be good hedges to inflation. Additionally, although there may be short term pain in the fixed income portion of your allocation, in time, you will see greater interest rates.
If you find yourself feeling jumpy and you’re looking for “what do I do?!” there are three things that you can do immediately to help yourself out:
- Evaluate your asset allocation to make sure it is appropriate for your ability and willingness to take risk. Inflation might change your ability, and if you’re feeling jumpy then you might not be willing to take as much risk.
- We’ve had a correction. Your allocation is likely at least 10% underweight stock. Consider rebalancing into the cheaper prices.
- Wait out the volatility. This is a psychological game. It may include deleting social media and watching movies instead of cable news. You might need to exercise more or do whatever you need to do to ignore a day-to-day change in your portfolio.
I know I’ll be waiting it out, right here with you.