Over the last few years investors have had a smooth run riding the markets upwards. But the last two weeks has seen volatility wreak havoc on the markets. For many new investors, this is possibly the first time they have experienced volatility of this sort. The last time markets were this volatile was back in 2018 and before that 2016.
But volatility is nothing to be afraid off. In fact, it is a natural part of the markets. It is something that needs to be tolerated in order to unlock the vast wealth creating nature of the stock market.
The most successful investors not only tolerate, but they also embrace, the volatility in the price of things they own. And for you to become successful, you too will have to embrace and tolerate volatility. This can be done in a number of ways, including:
1. Own cash producing assets , as money getting deposited into your account can countervail short-term irrationality. I personally invest in dividend growth stocks as seen by the ‘my journey’ section of this site. There is a huge mental advantage of volatility and falling stock prices for me as I know that I can use any dividends received to buy shares at lower prices than before. I don’t see people getting annoyed when the shoes they have been eyeing up go on sale. Likewise, you shouldn’t be annoyed when stocks in great companies go on sale.
2. Understand what you own so that you do not confuse the prevailing market prices for actual underlying intrinsic value. The current stock price does not always give an indication of how a business is performing. Stock prices may move for a number of reasons including sentiment, momentum and/or a wider market move. If a company you are invested in has an intrinsic value of £100 a share but it is currently trading at £80 a share, there is no reason to panic. And you are less likely to panic if you understand what the business is, how it generates its revenue, what its future prospects are and the how robust its balance sheet is.
3. Understand stock market and individual company histories so that you do not treat usual variances as once in a lifetime events. Some industries and business have historically been more cyclical than others. Oil stocks are a good example of this. Investors in this sector must brace themselves for a crash of 20%+ every few years. Just look what happened in 2015/2016, well capitalised companies such as BP and Shell fell 50%+. Many investors at the time were felling from oil related stocks. But because I am a student of the markets and history, I understood better. I took these over exaggerated falls and bought stock in BP and Shell at depressed prices locking in dividend yields in the 9%+ range. I used volatility to my advantage to buy into these stocks at a discount and have been rewarded handsomely since then. This is not to brag, it is just to show you the importance of understanding what you own and having a knowledge of financial history.
As an investor, you shouldn’t worry about the short term. You shouldn’t focus on short term price moves. If you don’t plan on being invested in the stock market for at least 5 – 10 years, you shouldn’t be investing at all. This is because time horizons matter. The longer you are invested in the market, the less chance you have of making a loss. Just look at this chart to see how losses are shortened the longer ones time horizon becomes.
All this is to say short-term experience of a paper loss is the worst enemy of the investor. It prevents otherwise intelligent people from getting rich through the accumulation of passive wealth in a basket of stocks. The silver lining is that this emotional tendency does provided the irrationality in the market that it makes it possible to get good deals. That said, I would much prefer to make money from earnings growth compared to P/E changes because the former benefits from building something whereas the latter benefits from taking advantage of someone else. Favourable life results in the investment markets are entirely conditioned upon tolerating possibly extreme fluctuations in net worth, and it is wise to develop a strategy that takes your own emotional tolerance into account so that you do not forfeit wealth by selling low.