The market has gone up over time.
But not all the time; far from it.
And therein lies the challenge, for you can’t have one (long-term gain) without the other (short-term pain).
Since 1990, the S&P 500 has returned an impressive 10% per year. And it’s done so despite two 50+% bear markets and being in a drawdown 90% of the time.
Which means that risk is clearly a feature in markets, not a bug, and the main reason why you earn a premium from holding equities over the long run.
But when volatility rises and markets fall, that perspective can be lost. Panic sets in and with it comes the urge to sell. Acting on that urge can be disastrous for investors.
Because panic creates opportunity, and if you’re a long-term investor you want to be a buyer of opportunity, not a seller.
When volatility is at its most extreme levels, the news is filled with nothing but negativity (war, recession, unemployment, bankruptcy, pandemic, etc.). During such times, investors tend to overreact, assuming that things will never get better again. This drives prices and valuations down and prospective long-term returns up.
The evidence is clear…
After the highest 10% of weekly closes in the Volatility Index ($VIX above 28.6), the S&P 500 has posted average returns over the next one to five years that are not only positive but well above periods when volatility was lower.
And following the 20 highest weekly closes in the $VIX, we’ve seen the strongest future returns on average.
All of these data points occurred during recessions and bear markets when it seemed as if the world was coming to an end. But it didn’t, and investors who embraced the panic would ultimately reap the rewards. Which is another way of saying that every recession and bear market of the past was eventually followed by an economic expansion and new all-time high in the future.
In 2022, we are once again faced with a highly volatile market, one filled a myriad of reasons to panic and sell (inflation, rising interest rates, Fed tightening, war, economic slowdown, etc.).
The only reason to hold on is the lesson we’ve learned countless times throughout market history.
And that lesson is this: the biggest mistake an investor can make is turning temporary volatility into a permanent loss. That loss is not just the realized one from selling during a drawdown. But also, more importantly, the loss of opportunity to generate real wealth in the future.
“The first rule of compounding is to never interrupt it unnecessarily.” – Charlie Munger
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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures, click here.