Turn on a financial news channel these days and it’s likely someone is providing various reasons on why it is not a good time to invest in the markets. Many investors, bombarded by the influx of anxiety-inducing headlines, may be questioning if they should start investing or completely exit the markets. As with most things in life, however, there are things you can control and things you can’t. This is also true with investing.
The good news about investing is that markets have rewarded investors over the long term. But over the short term—as anyone who has paid attention knows—markets go up and markets go down. We have seen this to an extreme through the first half of 2022.
However, this volatility should not deter us from investing, but rather it highlights the importance of looking beyond short-term returns and being aware of the range of potential outcomes.
Dimensional Founder and Executive Chairman David Booth recently shared his perspectives on the merits of long-term investing. Imagine it’s 25 years ago, 1997: J.K. Rowling just published the first Harry Potter book. General Motors is releasing the EV1, an electric car with a range of 60 miles. The internet is in its infancy, Y2K looms, and everyone is worried about the Russian financial crisis.
A stranger offers to tell you what’s going to happen over the course of the next 25 years. Here’s the big question: Would you invest in the stock market knowing the following events were going to happen? And could you stay invested?
- Asian contagion
- Russian default
- Tech collapse
- Stocks’ “lost decade”
- Great Recession
- Global pandemic
- Second Russian default
With everything that’s happened, would you have gotten into the market? Gotten out? Increased your equity holdings? Decreased them?
Well, the data tells us a compelling story. From January 1997 to December 2021, the US stock market returned, on average, 9.8%1 a year. In other words, a dollar invested at the beginning of this period would be worth about $10.252 at the end of the period.
What can we learn from this anecdote? There were clearly a lot of negative surprises over the past 25 years, but there were a lot of positive ones as well. The net result was a stock market return that seems very reasonable, even generous.
Investing in the stock market is always uncertain. Uncertainty never goes away. If it did, there might not be a reward. It’s because of uncertainty that we have a positive premium when investing in stocks vs. relatively riskless assets.
Recent volatility and disappointing results have tested many investors' faith in sticking true to their investment philosophy, but we know that reacting emotionally to volatile markets may be more detrimental to portfolio performance than the drawdown itself.
While there is no silver bullet, understanding how markets work and trusting market prices are good starting points. By adhering to a well-thought-out investment plan, ideally agreed upon in advance of periods of volatility, investors may be better able to remain calm during periods of short-term uncertainty.