We all wish investing could be as easy as putting your money in the markets for a couple of months or years and leaving with a guaranteed 100% return. Unfortunately for us, investing is not quite that simple. Successful investing comes at a price, and this price is volatility.
Holding stocks for the long run is the best investment advice you can get, but do you know how hard it can be to maintain a long-term outlook when stocks are collapsing? A key challenge for many investors is understanding the crippling effects fear can have on personal investment decisions. For some investors, a 40% drop in price might be too much to bear, while for another investor, 10% is about the max loss they can take. Amazon (AMZN) since going public in 1997 has gone up 186,736.99% at the time of writing this article. In hindsight, Amazon would have been the perfect company to hold your retirement investments in, but the price of success during this period was dreadfully high. Imagine putting your entire savings in a company that only sold books back then. In November 2001 Amazon’s stock dropped to a low of $6.72 from a previous high of $107.13. That translates to a 93% loss. I do not have to tell you how hard it is to see your wealth disappear into thin air. You would have needed a tremendously strong conviction in Amazon in order to continue to hold on and realize the current value of Amazon stock which is $3231.80.
Human beings are loss averse; Nobel Prize winner Daniel Kahneman and his partner Amos Tversky understand that the pain of losses can be twice as painful as the pleasure experienced through gains. (see graph below):
Our human DNA is hardwired to experience a loss with way more intensity than we would experience a win. Economists monitored the happiness of thousands of fans during years of British soccer matches. Controlling for variables like the time of day and location, they observed happiness fluctuations before, after and during the games. On the scale they used, fans were 3.9 points “happier than usual” with a win for their team and 7.8 points sadder if their team lost (see graph below):
Morgan Housel in his best-selling book, The Psychology of Money, poses a question as to why people are willing to pay the price of cars, houses, food and vacations, but find it so hard to pay the price of a good investment return. The answer is that price of investing success is not immediately obvious. Volatility in the market feels like a fine. Our natural human instinct is that a fine means you have done something wrong. The natural response is to cut your losses short and avoid an even bigger fine. The truth is volatility in the market is to be expected. Since 1926, the stock market has never had a 15-year stretch where it did not make money. During that time, we have had The Great Depression, a World War, Black Monday, the Tech Bubble, the 9/11 attacks, the Housing Bubble of 2008 and multiple epidemics. The truth is, if you want to get a good return in the long run you must play by the rules of the market.
All things considered, volatility can be very hard on the psychology of investors. One can find themselves selling too early to lock in profits, or they might hold on to a loss in the hope that it turns into a profit. Uncertainty, doubt, and regret are common costs in the financial world that are felt by every investor. Nothing worth while comes easy and investors should view volatility as a fee worth paying to get something in exchange. Know your investments and understand the fundamentals of everything you put your money, that way you have a greater control of the emotions that come with investing.
- Kondwelani Kalinda, Financial Planning Assistant
Kondwelani Kalinda is a Financial Planning Assistant at Endeavour Wealth Management with iA Private Wealth, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Kondwelani Kalinda who is a Financial Planning Assistant for iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors.