Investing in stocks? Expect Volatility

One of the lessons I’ve learned over the years is that a critical part of my job is setting expectations. Since late 2012, US stocks have really marched steadily upward with no major pull-backs. This type of market environment tends to create a false sense of security.

In recent weeks, we’ve finally started to see some choppy-ness in the markets. That said, now seems like an opportune time to remind clients of the realities of investing in marketable securities, such as stocks, and why you work with a financial advisor.

There are two things that I cannot emphasize enough:
First, whenever you have exposure to the stock market, in particular, THERE WILL BE TIMES OF

VOLATILITY AND SIGNIFICANT NEGATIVE PERFORMANCE.

Second, WE CANNOT PREDICT WHEN THESE PERIODS OF VOLATILITY AND NEGATIVE PERFORMANCE WILL OCCUR, NOR WILL WE BE ABLE TO SIDESTEP THEM (for the record, we are of the view that no one can).

In-fact, I closely follow many of the world’s most famous and successful investors. Among them are Warren Buffett, George Soros, John Paulson, Bill Ackman, David Einhorn and Seth Klarman to name a few. None of these individuals, many of whom have compiled the best investment records in modern history, at the end of 2007 predicted a market crash and avoided the massive sell-off which was to come.

Let’s transition this discussion to the idea of owning publicly traded companies (stocks). Some may ask the question, why bother putting money into something that seems so unpredictable? The answer is simple. Stocks have historically been shown to be the highest returning asset class. Don’t ever forget that stocks aren’t just little ticker symbols with prices that move around every day. They represent fractional ownership of real businesses.

Businesses are what have created the greatest wealth the world has ever seen. Not just the names of yesteryear (think Vanderbilt, Rockefeller, Carnegie, JP Morgan, etc.). Consider the top 15 people on the most recent Forbes 4001 list:

1. Bill Gates (Microsoft)
2. Warren Buffett (Berkshire Hathaway)
3. Larry Ellison (Oracle)
4. Charles Koch (Koch Industries)
5. David Koch (Koch Industries)
6. Christy Walton (Wal-Mart)
7. Jim Walton (Wal-Mart)
8. Michael Bloomberg (Bloomberg LP)
9. Alice Walton (Wal-Mart)
10. Rob Walton (Wal-Mart)
11. Mark Zuckerberg (Facebook)
12. Sheldon Adelson (Las Vegas Sands)
13. Larry Page (Google)
14. Sergey Brin (Google)
15. Jeff Bezos (Amazon.com)

1 Source: http://www.forbes.com/forbes-400/. Accessed 10/04/2014.

The wealth of all these people has been created not by gold, not by real estate, nor by natural resources. It has been created by businesses.

One of the great developments of the past several centuries is that of publicly traded companies. This idea allows even individuals with very modest sums to invest in the most profitable businesses in the world and participate in the handsome returns that they can offer. The trouble is, in my view, public markets are too easy to take money in and out of. Additionally, daily pricing easily lends itself to speculation. The combination of these two factors can lead to wild fluctuations in price for reasons disassociated with the fundamentals of the underlying investment.

This brings me to my next point, which is critical for clients to remember, especially as you consider expectations for your own portfolio. Depending on what benchmark you look at, the long-term average return stocks have realized is in the upper single digits annually, including dividends. This is what everyone is trying to capture. The problem is, the “average,” is just that. Historically, to get that nice looking average, you’ve had to accept a lot of volatility. Just look at the annual total returns of the S&P500 going back to 20082. They perfectly illustrate this point:

2 Source: http://us.spindices.com/indices/equity/sp-500. Accessed 10/04/2014.

As you can see, the average sure looks nice, being just north of 9%. But again, to realize this, you would have taken quite a ride, particularly in 2008. This is the nature of investing in the stock market and there is no reason to expect it to change.

Unfortunately, price volatility can have an immense psychological impact on individuals. I’ve personally bore witness to this, especially during the depths of the recession in 2008-2009, and more recently, in the fall of 2011. These are the moments when individuals tend to make terrible investing decisions which can devastate wealth.

More and more I’ve learned that the most significant value financial advisors bring to their clients is helping them from making huge financial blunders (such as selling at the bottom, investing a significant sum in a speculative idea, attempting to time the market or investing too conservatively). The trouble for financial advisors is, how can you ever quantify or measure the value you’ve created by talking clients out of making a bad decision? The answer is, you can’t, even though it could mean hundreds of thousands of dollars (or more) to your client over time.

So as you review your monthly investment statements, or view your accounts online, remember:

1. When investing in stocks or other marketable securities, THERE WILL BE TIMES OF TURBULENCE AND NEGATIVE PERFORMANCE.
2. Neither your financial advisor, a talking head in the media, or relative you see over the holidays can predict when these instances will occur.
3. You don’t hire a financial advisor to time the market. You hire an advisor to:

• Get their professional advice on the best investment strategies and financial instruments based on your financial needs and objectives;
• Save you the time and worry of doing it yourself; and 
• Help you avoid making costly financial mistakes.

Remembering and understanding these points is critical in establishing realistic expectations for your investments and the role of your financial advisor.

As always, we thank you for your ongoing trust and support. If you ever have any questions or concerns about your accounts, please don’t hesitate to reach out to our office.