If you were watching the first half of 2021, it wouldn’t be hard to assume that the stock market only moved in one direction – up. Sure, it had an occasional down day, but those were few and far between and relatively muted. You could also be forgiven for assuming this steady march would continue. We all fall prey to “recency bias” which simply means our brains tend to favor recent events over historic ones – things that happened last week count more than the stuff that happened last year.
But September came and reintroduced us all to the concept of volatility. Guess what? Not only can markets go up and down, we actually need them to. When markets only go up, there is no risk. When there is no risk, returns will be lower. This is why your bank CD pays less than the market – there is far less risk. We need these types of shake-ups to remind everyone that investing involves risk.
But the amount of risk you face depends entirely on your perspective. For many years, I’ve used this analogy. Picture yourself playing with a yo-yo while walking up a flight of stairs. Are you more likely to reach the top safely if you focus on the yo-yo or the landing at the top? When we focus on the ups and downs in the short-term, we are much more likely to get distracted and lose our focus on our ultimate goal.
Let me give you another perspective. Just a month ago, the market achieved an ALL-TIME HIGH – the highest the market has ever been… in all of time. But let that sink in. That means the market has experienced and recovered from every downturn in history. Every war, terrorism event, presidential assassination, financial crisis, pandemic; every political election, scandal, major news event, weather event or any other event that has temporarily impacted the market. The market not only recovered from these; it went on to hit a new high each time. The issue is not whether the market recovers, it is always a question of when it recovers.
If you have a financial plan (you should!), it should include stress tests that help you and your advisor understand how your portfolio and plan is affected by volatility. Because investors know that (1) volatility will happen; (2) the market will always recover; but (3) we don’t know how much time it will take to recover. So, it is important to know how sensitive your plan is to these periods of market wonkiness.
Try to ignore the daily/weekly ups and downs; keep score using your long-term goals and how likely you are to achieve them. My clients always have real-time access to their plan score so they can see that the long-term score is not affected much by the daily bouncing around.
The core lesson here is… don’t play with a yo-yo while walking up a flight of stairs!
Photo: "Yo-Yo" by Enrique Calabuig, licensed under CC BY-SA 2.0.