The Price of Return

Virtually every investor in the stock market knows that investing can be risky. But how risky are they and what exactly does "risk" mean on the stock exchanges? Opinions differ on how risk is defined. We like the definition of Elroy Dimson, a famous economist: "Risk means more things can happen than will happen." Human behavior is very strongly influenced by emotions and this is no different on the stock exchanges. Just as stock prices can overshoot during rising markets, they can also undershoot during bad phases. Of course, falling stock prices are extremely unpleasant, but they also repeatedly offer entry opportunities for long-term investors. In summary, a stock investor should be amply rewarded in the long run for the risk they expose themselves to. In the past, this has always been the case and we believe this will not change in the future. The following 5 facts should help investors survive stock market fluctuations without sleepless nights:

1. Identifying major price losses (market timing) is impossible

We would all love to be able to time the markets to avoid losses. History and data suggest to us that this is nearly impossible. If it were possible to identify these market downturns and thus only be invested when markets are rising, one would very quickly become one of the richest people in the world. Unfortunately, investors have to go through the painful downturns of the stock market to be amply rewarded in the long run.

2. Even professionals cannot avoid market downturns

In the past, stock markets have gone through periods of major price losses more frequently than investors might think. If you, as an investor, think only amateurs cannot avoid market downturns, you are mistaken. Two facts on this: (1) Even with the most successful long-term managers, there are major setbacks. (2) There is no correlation between a manager's long-term performance and the extent of their largest performance drops.

3. Losses are inevitable (but not in the long run)

Going back in history to 1900, you can see immediately that stock markets can be incredibly volatile over a one-year period. Drops of 10% to 30% are relatively common. Over a 5-year period, however, declines become much rarer. With a holding period of 10 years, they are practically non-existent, and over 20 years there are no periods of negative returns. Conclusion: The longer the holding period, the higher the probability of a positive return.

4. Even Warren Buffett cannot escape volatility

Many of us would love to permanently achieve a 20% annual return without the value of the investment ever decreasing. The only ones who succeed in doing so are the Bernie Madoffs of this world, because they are eventually exposed as fraudsters and hopefully end up in prison!

Berkshire Hathaway (Warren Buffett's investment vehicle) recorded four years in which it fell by more than 20% and six years in which it underperformed the S&P 500 by more than 20%.

5. Equities reward investors very well in the long run

So, if you have endured these occasional 50% setbacks and the more frequent 20% corrections, you should, as mentioned, be amply rewarded. But how amply? An investment of $100 in the US stock market in 1899 would have grown to $9,994,326 today! Hard to believe, but true! The short-term risk of equities was thus more than amply rewarded in the long run.

No risk, no reward

Volatility and market downturns are therefore the price a stock investor has to pay for higher returns in the long run. You really cannot have the sweet without the sour.

The stock market is an instrument to transfer money from the impatient to the patient. We remain patient!

As always, thank you for the trust you have placed in us!