%20transparent.png){kind=small}
Macroeconomic headwinds blowing against markets
The stock market year 2022 has so far been characterized by above-average volatility and sharp price losses. Due to continuously rising inflation figures, triggered by sharply rising commodity prices as well as persisting supply bottlenecks, central banks in the major economies were forced to raise interest rates quickly and massively. Calls that the USA is heading for a recession are therefore growing louder. In addition, the war in Eastern Europe is creating fear and uncertainty.
Virtually every investor in the stock market knows that investments can be risky. But how risky are they and what exactly does "risk" mean in the stock markets? Opinions differ on how risk is defined. We like the definition of Elroy Dimson, a famous economist: "Risk means that more things can happen than will happen." People's actions are very much influenced by their emotions and this is no different in the stock markets. Just as stock prices can overshoot when the stock market is rising, they can also undershoot during bad periods. Of course, falling share prices are extremely unpleasant, but they also offer long-term investors opportunities to enter the market. In summary, a stock investor should be handsomely rewarded for the risk he exposes himself to in the long run. 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 get through stock market fluctuations without sleepless nights:
1. Recognizing major price losses (market timing) is impossible
We would all like to be able to time the markets to avoid losses. History and data suggest that this is nearly impossible. If it were possible to recognize these price drops and thus only be invested when the stock market is rising, one would very quickly become one of the richest people in the world. Unfortunately, investors have to go through the arduous price drops of the stock market in order to be richly rewarded in the long run.
2. Even professionals can't avoid price drops
Stock markets have gone through periods of large price declines in the past, more often than investors may think. If you as an investor think that only amateurs cannot avoid price drops, you are mistaken. Here are two facts: (1) Even the most successful long-term managers experience major setbacks. (2) There is no correlation between the long-term performance of a manager and the extent of the biggest performance drops.
3. Losses are inevitable (but not in the long run)
If you go back in history to 1900, you can immediately see that stock markets can be incredibly volatile in a one-year period. Drops of 10% to 30% are relatively common. However, over a 5-year period, the declines become much less frequent. At a holding period of 10 years, they are virtually non-existent and at 20 years, there are no periods of negative returns. Conclusion: The longer the holding period, the greater the probability of a positive return.
4. Even Warren Buffett cannot escape volatility
Many of us would like to achieve a permanent annual return of 20% without the value of the investment ever decreasing. The only ones who succeed in doing that are the Bernie Madoffs of this world but they will eventually be exposed as frauds and hopefully end up in jail!
Berkshire Hathaway (Warren Buffett's investment vehicle) had four years where it fell more than 20% and six years where it underperformed the S&P500 by more than 20%.
5. Stocks reward investors very well in the long run
So, as mentioned, if you endured those occasional 50% setbacks and the more frequent 20% corrections, you should be handsomely rewarded. But how handsomely? A $100 investment in the U.S. stock market in 1899 would have grown to $9,994,326 today! Hard to believe, but true! So the short-term risk of stocks was more than handsomely rewarded in the long run.
No risk, no reward
Volatility and price drops are the price an equity investor has to pay for higher returns in the long run. You really can't have the sweet without the sour.
The stock market is a tool to transfer money from the impatient to the patient. We remain patient!
Comments