Morgan Housel, one of my favorite finance writers, tweeted, “This is the cost of admission” when markets were down big last week.
He is so right.
The stock market is one big amusement park, stocks are the roller coasters and the cost of admission is volatility. To step inside the park, you must be able to handle ferocious up and downs. It’s inevitable.
To members this morning I wrote,
“Nothing changed with the theses of our holdings yet, most stocks have declined 20-40% from highs. However, it shouldn’t be a surprise. This is what the stock market does.
Being surprised by this is like moving to Antarctica and being surprised it’s cold outside. That’s just the game.”
It’s not fun when stocks are down big but that’s why setting expectations is important. Thinking that great investment returns will be easy is foolish. Investing is hard.
Numbers Don't Lie
2017 spoiled us. It was the least volatile year in decades. For the entire year, the S&P 500 didn’t make a single daily change, positive or negative, over 2%. And only nine 1% moves.
On the other hand, 2018 has been much crazier. We have seen nineteen moves greater than 2% and sixty-three 1% moves.
So 2018 has been no joke for volatility. But what are the upper limits of how bad it can get? To give you some context, let's look at how the past two years stack up against the Great Financial Crisis of 2008.
At a glance, 2008 had more than twice the 1% moves and well over three times the 2% daily changes.
2018 has been crazy. But not 2008 crazy.
Ticket Stubs Please
Volatility is the cost of admission to the amusement park that is the stock market. As David Gardner likes to say, "Stocks go down faster than they go up but up more often than they go down."
And that's what it's all about. Staying in the game long enough to let compounding do its magic. To quote Charlie Munger, "Never interrupt compounding unnecessarily."
However, I don't want to sugarcoat it. Volatility is scary. Seeing your portfolio down big and calculating how much you have lost from all-time highs is draining.
But if markets went up and to the right all the time, everyone would pile in, then the assets would get priced too expensively, ending in a bursting bubble. That's why volatility is important. It releases the pressure so that bubbles don't form.
It's just like a scuba diver.
Divers must take their time at certain depths so as not to get air bubbles in their blood. If they surface too quickly, they can get decompression sickness, aka The Bends. It's the same way with markets. If they never take their time to decompress along the way, dangerous bubbles will form.
Applying It
By viewing volatility as a necessary evil we can become more at-peace with it. Volatility is not wealth destroying unless we allow it to be; it's actually neutral.
If the drops lead us to sell, it's wealth destroying but if we go against the crowd and buy when it is uncomfortable, volatility is helpful; a discount on the cost of admission.
Focus on the business results and let volatility runs its course. Easier said than done so make sure you have the right expectations. Tickets to this amusement park ain't always cheap.
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