Why Market Volatility Is Good for Long-Term Investors
Key Takeaways
- Market volatility is uncomfortable, but it is one reason long-term investors have historically earned higher returns.
- A solid financial plan allows you to stay invested during market downturns.
- Keeping enough cash for near-term expenses reduces the temptation to sell investments at the wrong time.
- Successful investing is not about avoiding volatility. It is about preparing for it.
My Golf Driver Story
My wife loves teasing me about my golf driver.
Every time we play, she has several "witty" comments ready.
But I like my driver.
Yes, it's 25 years old.
Yes, it's small. I prefer to call it normal-sized.
And yes, it's outdated technology.
Like a tennis racket, every golf club has a sweet spot. That is the ideal place to strike the ball.
Older clubs have much smaller sweet spots than today's oversized drivers. That means it takes more skill to consistently hit long, straight drives.
And honestly, that's part of the fun.
I'm much more satisfied hitting a great drive with my old club than I would be using the latest technology.
What Does This Have to Do with Investing?
Volatility measures how much investment prices move up and down.
Most investors dislike volatility because it makes their portfolios fluctuate.
But those fluctuations are one reason long-term investors have historically earned higher returns.
Think about it.
- If markets never declined, everyone would invest.
- Very few people would ever sell.
- Prices would remain permanently high.
- Future returns would likely be much lower.
Instead, markets constantly move as buyers and sellers react to new information.
Sometimes optimism pushes prices higher.
Sometimes fear pushes them lower.
That uncertainty creates opportunities for disciplined, long-term investors.
Why Market Declines Can Be Good
During major market declines, fear spreads quickly.
Some investors sell because they panic.
Their selling pushes prices lower.
Lower prices create even more fear, causing additional investors to sell.
The cycle reinforces itself.
Long-term investors take a different approach.
Instead of running from falling prices, they recognize that lower prices can create better long-term opportunities.
That does not mean market declines are enjoyable.
It means they are expected.
And they are already part of the plan.
Don't Invest Money You'll Need in the Next Five Years
So how do you stay calm during market declines?
By having a Financial Plan.
A good financial plan identifies the cash you'll need over the next five years and keeps those funds safely in savings instead of the stock market.
Historically, most five-year investing periods have produced positive returns, even after significant market declines.
Because your near-term expenses are already covered, you do not have to sell investments simply because markets happen to be down.
That peace of mind is incredibly valuable.
But How Can We Be Confident Markets Will Recover?
There are no guarantees.
Markets can stay down longer than we'd like.
That is why confidence should not come from predicting markets.
It should come from having an investment philosophy that can survive difficult markets.
If markets remain down for an extended period, you will have decisions to make.
You might continue using your cash reserves.
Or you may decide it is time to begin selling investments.
Every situation is different.
There is no single correct answer for everyone.
What Gets in the Way?
We do.
Human psychology evolved to help us survive danger.
When we feel threatened, our instinct is to run.
That instinct served our ancestors well.
It does not serve investors nearly as well.
When markets fall, fear tells us to sell.
Selling simply locks in losses.
When markets soar, excitement tells us to invest even more.
That often happens just before expectations become unrealistic.
Successful investing requires us to act differently than our instincts suggest.
Here's the Good News
Once you understand how volatility works, the solution becomes simple, even if it is not always easy.
Maintain enough cash for your short-term needs.
Invest the rest in a diversified portfolio.
Stay disciplined through both good markets and bad.
Eventually, volatility becomes less like an obstacle and more like the small sweet spot on my old golf driver.
It requires patience and discipline. But when you stay the course, the long-term rewards can make the challenge worthwhile.
The truly long-term investor wins.
Do you have questions about protecting yourself during uncertain markets? I'm here to help.
To share your comments, send me an email at Joe@BestFinLife.com.
If you're ready to improve your financial life, schedule a complimentary virtual conversation here.
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