We seek instant gratification. Ask Alexa or Siri and we can answer any question or watch any movie. But our increased desire for quick solutions has made investing well much more difficult. None of our tech-driven time savers have changed the fact that investing requires the ability to be patient over a long time horizon. Patience is not easy. It requires an understanding of both our capacity to weather a drop in the portfolio’s value and our emotional tolerance to stay the course during volatile times.
Stock markets appreciate over time
Since 1926, a diversified portfolio of stocks out-performed U.S. Treasury Bills 85% of the time if invested for ten years. An investment in the stock market twenty years ago would have almost quadrupled, even though this period includes both the bursting of the tech bubble and the Great Recession.
These attractive returns come with a significant degree of volatility. During the past twenty years, the U.S. stock market (represented by the S&P 500 Index) had a negative return one out of three months. Even measured on an annual basis, the stock market has had a negative year 25% of the time. The exceptionally low volatility during the recent past may have led us to forget what is normal.
Much can happen in ten years
Since stock market investing is attractive for time horizons of at least a decade, we need a more stable pool of assets for when the unexpected happens. Our income may be less than hoped for. A child may choose to stay home longer than planned. An anticipated windfall may never come to pass. Having a stable pool of assets to draw upon provides us with the capacity to avoid selling stocks just when the markets are going through a bad period.
Volatility induced anxiety
The second investor-specific risk is our ability to manage the emotional strain of volatile markets. Even if we acknowledge that our stock market investment is for our long term needs, a ten or twenty percent drop may lead to sleepless nights. Financial wealth should reduce anxiety, not increase it. Beyond the impact on our health and happiness, there is the risk that our emotions will drive us to sell the stocks at an inopportune time.
Knowing that stocks are volatile is different from experiencing it. Research by JPMorgan found that over the past two decades, the average investor’s return was less than a third of the return from a passively invested balanced portfolio, due in part to buying into markets close to a cyclical high or selling at a low point. An investment strategy only works if it is maintained over time.
Our risk tolerance may change
Our capacity and tolerance for volatility may change over time. The earlier we identify a shift, the better off we will be in the long term. If cash needs are pressuring us to withdraw more than planned, our risk capacity may have decreased. If we are sleeping less soundly, our tolerance for volatility may have changed. Do not rush any decision to adjust the allocation to volatile assets. Discuss it with someone and, if a shift is necessary, implement it gradually.
In investing, patience is a necessity.
To read more about how HTG helps clients reduce anxiety around investing and sleep well at night, read our blog A Sensible Approach to Allocating Wealth.
