The Necessity of Uncertainty
The second quarter of 2024 brought market movements that served as an excellent reminder of the randomness and unpredictability of financial markets. In July, the unwinding of a popular investment strategy among active investors known as a carry trade caused global markets to drop 8% in two weeks only to reach new peaks in the following three weeks. September brought more volatility as investors eagerly anticipated a decision by the Federal Reserve to cut the Federal Funds rate for the first time since March of 2020 given signs of cooling inflation and tightening in the labor market. During this time, the S&P 500 dipped over 4% in the first week of September and then fully recovered just days before the Fed’s September meeting.
These events remind us that stock market declines can happen for countless reasons, as seen in the chart below, and are a normal - in fact, a necessary - part of the market cycle. Market downturns can be unnerving and can spook investors in the moment, creating the urge to sell in a panic after seeing the value of their portfolios drop so quickly. However, the goal-focused, long-term investor can view volatility with detached curiosity and take comfort in the fact that 1) their financial plan accounts for the possibility of these events with a sufficient buffer of bonds for those withdrawing from their portfolio, 2) their dividends will be reinvested in lower priced shares, and 3) for those still adding to their portfolio, their savings will also be invested in lower priced shares. In the end, do these temporary declines matter for a 30-year investment plan tailored to match an investor’s financial goals? If history is any indication, they probably do not.
The randomness of short-term volatility creates uncertainty for investors in stocks. Uncertainty is a risk for investors, but it is only with risk that investors are rewarded. If all investment outcomes could be predicted with perfect accuracy, investors would only earn the risk-free rate of return. With lower investment returns, future goals would be more expensive to fund and save for in the present. So, with a long-term orientation, investors can take advantage of the returns earned by taking on market risk.
Looking ahead, investors face more uncertainty as the presidential election looms, with the result having important implications for policy and governance. However, history has shown that the US stock market has appreciated steadily over the long term regardless of which party is in power. The key takeaway for investors is to focus on the long term. Companies will continue to compete and innovate to earn profits and protect shareholder wealth, consumers will continue to want more and more goods and services, and investors can benefit by staying in their seats no matter who is elected president.
Uncertainty creates opportunity. A goal-oriented, long-term investor does not wish for uncertainty to disappear, but rather takes advantage of the opportunity that uncertainty creates. Riding out the valleys and troughs that the market experiences from time to time are a necessary price to pay – and really, all that is required -- for achieving equity returns over the course of an investment lifetime.
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