We have an official correction!
Sorry if that comes off a bit too happy about the market’s poor performance. As great as last year’s performance was, it was frustratingly boring for someone looking for bargain prices.
Yesterday, the Dow and S&P 500 both finished 10% below their previous high from two weeks ago.
If we learned anything this week, it’s that market volatility still exists. In other words, the past year was abnormal for volatility.
But for those of us with a long-term perspective, this is good news (net buyers of stocks should want lower prices).
Unless – and here’s the caveat – stocks were too large of a portion of your portfolio. The lack of volatility last year made investing seem easy (January’s performance only added to that sentiment). It also added a false sense of security.
Some investors took that calm market to mean stocks were now less risky. Some just became complacent. This week’s rise in volatility is a nice reality check for anyone who made that mistake and held a larger portion of stocks than they can comfortably handle.
The only thing that matters during times like these is that you have a strategy you can stick to when the markets go up or down.
The best strategy for you, is not only one that makes sense, but one you can stick with. — Joel Greenblatt
The great thing about Greenblatt’s advice is that a “strategy you can stick to” sets you up in advance for weeks like this.
Markets fluctuate. Long calm markets are rare. When calm markets break, it freaks some people out. One investor’s panic creates another’s opportunity. Nobody gets rich from panicking.
And anytime investing seems easy, it’s worth it to be cautious.
Many investors consider price fluctuations to be a significant risk: if the price goes down, the investment is seen as risky regardless of the fundamentals. But are temporary price fluctuations really a risk? Not in the way that permanent value impairments are and then only for certain investors in specific situations.
It is, of course, not always easy for investors to distinguish temporary price volatility, related to the short-term forces of supply and demand, from price movements related to business fundamentals. The reality may only become apparent after the fact. While investors should obviously try to avoid overpaying for investments or buying into businesses that subsequently decline in value due to deteriorating results, it is not possible to avoid random short-term market volatility. Indeed, investors should expect prices to fluctuate and should not invest in securities if they cannot tolerate some volatility.
If you are buying sound value at a discount, do short-term price fluctuations matter? In the long run they do not matter much; value will ultimately be reflected in the price of a security. Indeed, ironically, the long-term investment implication of price fluctuations is in the opposite direction from the near-term market impact. For example, short-term price declines actually enhance the returns of long-term investors. There are, however, several eventualities in which near-term price fluctuations do matter to investors. Security holders who need to sell in a hurry are at the mercy of market prices. The trick of successful investors is to sell when they want to, not when they have to. Investors who may need to sell should not own marketable securities other than U.S. Treasury bills.
Margin of Safety by Seth Klarman
- Three Lessons for Investors in Turbulent Markets – M. El-Erian
- Don’t Forget What Causes a Recession – N. Smith
- Too Clever By Half – Epsilon Theory
- Stock Gyrations – Grumpy Economist
- Why Competitive Advantages Die – M. Housel
- Few Things are as Dangerous as Economists with Physics Envy – Aeon
- Making the Most of Second Chances – Farnam Street
- Annie Duke: Improving Decision Making (podcast) – Capital Allocators
- The Cognitive Biases That Convince You the World Is Falling Apart – Lifehacker
- Why American Workers Aren’t Getting A Raise: An Economic Detective Story – J. Tepper
- Silicon Valley’s Tax-Avoiding, Job-Killing, Soul-Sucking Machine – S. Galloway