DIY investors need a special kind of fortitude
Those who keep an eye on the stock market will have noticed that the it has been a little vile lately. (For those who don’t, I’m sorry to have brought it to your attention.) Anyone who checks their investments with regularity is probably feeling some combination of anxiety, uncertainty and frustration with a touch of nausea. The Canadian market has taken a nosedive over the past month, falling 8%, giving up all the gains made earlier this year to leave us down 4% since January 1st. The U.S. has also taken a big dip in the past month but at least it has returned 10% so far this year. (BTW, this is a good reminder about why geographic diversification is so important.)
In a past life, I would have gone on to explain why that is, what’s driving stock prices down. Now I realize that it doesn’t matter. Coming up with a list of “reasons” (which are often only speculations anyway) is not at all helpful. If you’re an investor – one who buys based on a plan and holds for the duration - none of that matters.
What does matter is that stocks go up and stocks go down but over the long run, they go up.
Understanding the history of the stock market
When I work with people who want to become do-it-yourself investors, the very first thing we talk about is market volatility. Why? If you're a long-term investor there is a 100% chance that the value of your investments will go down at some point. When you have no one to call and cry to, as is the case with DIY investors (ok, well, my sister calls me), you’ve got to have an unusually strong level of fortitude to stay the course.
People who have a financial advisor have someone to call for reassurance when their investments go down. It's the job of the financial advisor to remind them that market fluctuations are normal. Those who own mutual funds at the bank are probably inclined to ignore them, and if they notice a decline, don't get around to making an appointment with a bank person to sell them and just keep holding onto them (the right move, even if the reason is poor).
When you are a DIY investor, though, the sell button is a login away. It's easy to feel panicky and wonder whether you made a mistake with your investments. DIY investors need a special amount of stamina and that’s why talking about market volatility is job number one with my “Learn to DIY” clients.
Let me give you a taste of this lesson. Have a look at a long-term chart of the stock market. Below you can see one that goes back to 1929. What do we see? Ups and downs that straddle an upward-sloping trend line.
To emphasize the kind of endurance an DIY investor needs, I like to look at the investor experience during the tech bubble. In the years leading up to 2000, the U.S. stock market was on a tear. From 1995 to 1999, it rose for five years in a row at double digit rates: 34%, 20%, 31%, 27% and 20%. Can you imagine how much fun this was? Investors probably felt invincible. But what followed? You guessed it: a decline. The market then had three bad years, falling by 10%, 13% and 23% in 2000 through 2003.
Imagine you started investing in 1997. You have a good experience for the first three years but then comes 2000 and the bursting of the tech bubble. Between August and December of 2000, the value of your investment in US stocks falls by 13%. That hurts, but you know about market ups and down so you hold on. By March of 2001, you are down another 12% for a total of 25%. Keep breathing! Hang in there! September comes and you are down another 10%. But it’s not over. Thinking that 2002 will be the turnaround year, you ring in the new year with hope but by September, your holdings are down even more, for a total of a 46% decline since August of 2000. It feels relentless. It feels hopeless. You feel like a fool. All of your friends who told you the stock market was risky are now shaking their heads sadly in your direction.
You started doubting your conviction months ago and now you think that this time it’s different. The market will never recover. You need to cut your losses. It’s understandable if you made this choice– you’ve been through a lot and it’s time to end the pain.
However, the reality is that a DIY investor with a long time horizon needs to keep hanging in there. Selling in Sept of 2002 would have been a big mistake because over the next five years, the stock market rose by 87% to a new high (just in time for the financial crises). Happens every time.
Higher returns are worth the pain
Over the past 50 years, the U.S. stock market has returned 11% per year on average while the Canadian market returned 9% per year. That more than bonds and higher than inflation. That kind of return is why you invest and why you stay invested.
So yes, the stock market is little putrid right now but that’s just part of the cycle. Every time you look at your account or hear the market update on the radio, try this mantra: “It doesn’t matter, I am in for the long run, I made a good decision.” Because it’s going to be ok.