By Paul R. Ruedi, CFP®
Volatility in investing refers to how widely the return on an investment can fluctuate. Periodic stock market volatility is a reminder of some very important lessons in investing, and unfortunately, some investors learn these lessons the hard way. Here are five lessons you can learn from market volatility:
1. There Is No Reward Without Risk
Over the last nine years, stock investors have been treated to fantastic returns, in spite of historically low volatility. Market uncertainty like this reminds us of the deal we make when we invest in stocks—we trade short-term uncertainty for higher returns over long time horizons. There is always a chance of “trouble ahead,” or a temporary decline looming in the distance when investing in stocks. But we should not wish this uncertainty away, as it is the very reason we can expect higher returns from stocks over long periods of time.
2. The Stock Market Does Not Go up All the Time
It has been so long we have seen a major market decline, people seem to have forgotten the stock market does, in fact, go down sometimes. Those who started investing around 2012 have only known a pretty much uninterrupted upward march in the stock market. This was an unusual time. The market has gone nine years without a bear market (defined as a decline of 20% or more), which typically occurs every five years or so. Temporary declines of 30% and higher are commonplace. You will live through market declines like this; your investment journey will not just be smooth sailing the whole time!
3. Stock Investors Must Remain Invested at All Times
Wild swings back and forth remind us the majority of the positive return of the stock market happens in a few explosive days. Though it is tempting to try to time the market, you run the risk of missing out on the 3% “rebound” days that make up a huge portion of the long-term return of the stock market. People are always tempted to sit on the sidelines “until things get better.” But when things are observably better, stock prices are already higher, and they have missed the price rally. Once it occurs, the ship has sailed and you have missed out. There is no getting it back. (For related reading, see: Market Timing Fails as a Money Maker.)
4. Temporary Declines Help Young Investors
As a young investor, I personally hope any volatility turns into a full scale bear market because my mission is to accumulate as much ownership in the great companies of the world as I can. Why wouldn’t I want the stocks I intend to buy to go on a temporary “30% off” sale? This goes not just for young investors but anyone who is still purchasing or accumulating stocks they will sell down the road. A bear market should not be something to be feared, but a huge opportunity to buy even more stock at lower prices.
5. Many Investors Need an Advisor to Be Successful
Some people just don’t do well with the emotions of investing, and find themselves falling prey to fear during temporary declines or volatility. But these are the most important periods for investors to remain invested so they don't miss out on the returns stocks can provide. For this reason, many people need a financial advisor to talk to during times of crisis. (For related reading, see: How to Avoid Emotional Investing.)
An advisor who can recognize and understand your emotions, but still keep you from acting on them in a way that hurts you as an investor, can be priceless during times of market volatility.
Always Be Aware of the Possibility of Large Temporary Declines
Market volatility is a healthy reminder of the deal stock investors make when they take on the short-term uncertainty of stock returns for the long-term higher returns stocks provide. Investors must always be aware of the possibility of large temporary declines in the stock market, and commit themselves to remaining invested anyway. If they cannot remain invested by themselves, they may need to seek the help of a financial advisor.
(For more from this author, see: 5 Keys to Investor Success.)
This article was originally published on Investopedia.