Patience Pays

Keep calm and stay invested. Photo by Paul Harizan/Getty Images.

When stocks slip on a day-to-day basis, we here at MarketMinder often repeat the following message: Short-term volatility is the price to pay for equities' long-term gains. We realize this isn't a revolutionary statement. Many others highlight a similar message, citing the large amount of data supporting the claim. But as persuasive as the historical evidence is, investors must deal with a deafening amount of noise screaming why they shouldn't be in stocks -and that isn't even accounting for humans' natural tendency to avoid anything that immediately feels uncomfortable (e.g., a two-week market drop). That is a lot to handle! While it isn't easy, the process is also straightforward: Successful long-term investing requires staying disciplined and minimizing easy-to-make mistakes during sentiment-driven downturns.

The concept is simple: Long-term investors who require equity-like growth should own stocks the vast majority of the time. Why? Historically speaking, stocks have provided the best return of any similarly liquid asset class over longer time horizons. On a day-to-day, month-to-month, even year-to-year basis, stock returns can vary tremendously. Since 1926 stocks' long-term annualized average return is 9.9%^[i]-and that includes both bull and bear markets. Even if you're skeptical about stocks, what is a better alternative? Other asset classes lag stocks over the same timeframe.^[ii] US corporate bonds returned 6.1% while Treasurys provided 5.3% annualized. US muni bonds? Their annualized return was less than half of stocks' at 4.2%.

Now, we always caution investors from using past performance to forecast future returns-we aren't arguing stocks will do better than other assets just because they did so before. But unlike a commodity like gold-which has a fixed supply and limited use (demand)-stocks are slices of ownership in publicly traded companies. And companies (and their profits) can keep growing. Thus, we believe the onus on investors is not to find why you should own stocks, but rather, why you shouldn't. And in our view, the only reason investors should get out of stocks-provided their goals, needs and time horizon haven't changed-is if they see widely unnoticed negatives with trillions worth of economic impact as highly likely to become reality. Said differently, equity investors should exit only if they are very convinced a bear market (an extended, fundamentally driven market decline of -20% or more) is forming.

While many investors logically understand the importance of staying invested, the huge amount of noise-coupled with human emotion-tests even the most steely of nerves. First, consider myopic loss aversion (also known as prospect theory)-investors' propensity to feel the pain of loss over twice as much as the joy of an equivalent gain. This puts investors at an immediate disadvantage: Our brains are hard-wired to try and "stop the bleeding" when volatile markets fall. The drop-which becomes a real loss only if you actually sell-feels more real than stocks' long-term return potential, which is distant and off in the far future. This is especially true given so many investors remember being hit hard in the last two bear markets, a memory that motivates many to take action to avoid what your mind makes you think is a potential replay of those awful times.

Combine this with the onslaught of noise criticizing stocks as an investment class. Many investors who need equity-like returns believe they need evidence of widespread positive fundamentals to justify owning stocks-operating on the notion cash, not stocks, is their default position. But in our view, that logic should be flipped-fundamentals need to demonstrate a clear reason to not own stocks. After all, if you need equity-like growth, there is no shortcut to getting there other than owning stocks most of the time.^[iii] Thus, investors must battle internal and external forces to remain disciplined-a daunting challenge for anyone, expert or novice.

Likewise, any investor-pro, amateur, novice, old hand-can make a mistake by caving in to emotion and jumping out of stocks at the wrong time. In the heat of the moment, when markets are plunging, it can just feel like the rational thing to do. And when stocks stage their eventual rebound-like we have seen recently-it can be pretty disheartening to investors who panicked and jumped out. However, one bad move needn't jeopardize your long-term investment goals. If you're a long-term investor, remember mistakes and errors happen. They don't have to be fatal to your portfolio, so long as you internalize the lesson, reinvest your assets in keeping with your goals and don't repeat the mistake when markets inevitably get bouncy again.

To stress the importance of dealing with the market's inescapable dips, we have seen several pundits highlight stocks' trend of rising more than falling. To hammer this point, some have cited huge datasets, sometimes spanning almost two centuries. While we appreciate data, we also prefer reliable, consistent figures-and as far as we can tell, market data earlier than the late 1920s are of questionable quality. It also may not be a terribly helpful reference point for investors-most folks don't have time horizons of 100+ years. However, even over shorter stretches-10, 20, 30 years, a much more realistic time horizon for most long-term investors-stocks are superior to other asset classes. For example, over rolling 30-year periods since 1926, stocks have outperformed bonds 100% of the time.^[iv] 97% over 20-year rolling periods.^[v] For long-term investors, time in the market matters more than nailing the ideal time to exit or enter it.

However, this is all easier said than done-nothing about investing is easy. Throughout this bull market, headlines have bombarded investors with arguments, speculation and theories for why stocks look shaky. Many have fretted weak economic growth, from the US to China. Political uncertainty has been plentiful, from questions about the eurozone staying together to the fallout from a US government shutdown. Wonderings about monetary policy have persisted: Are central banks providing the market's only juice? What would be the impact if the Fed ended quantitative easing? Or hiked rates? These are just a handful of persistent worries. Yet the bull has charged on since its March 2009 birth. Yes, global markets have corrected six times throughout that period, as the bull's ascent has come in lurches and starts rather than a smooth, upward glide. But stocks don't move in neat, gameable patterns. Investors who can stomach this and remain disciplined through the market's bumpiness deserve kudos. But more important than kudos, they are also that much closer to making their personal investment goals a reality.