As we move into a new year together, it’s always a good idea to take an intelligent look at the most recent year for some historical perspective. Especially since it was such a volatile year.
Interestingly, I haven’t heard anyone, in any venue, describe 2013 as volatile.
Interesting because broad domestic equity prices went up roughly 30%. Yet, nobody referred to 2013 as volatile.
Had market prices fallen 30%, I suspect everyone would have labeled that as “volatile”. And, therein lies a great lesson in disguise for all of us.
Most Americans have a subjective definition of volatility, a challenge which has proven to be extremely detrimental to anyone with a strong desire for a relaxing retirement where their income keeps pace with ever rising costs during their lifetime.
Most define volatility as down a lot in a short period of time without realizing that what we just experienced in 2013, which was a rapid price increase, was equally volatile, just in the opposite direction!
The dictionary defines the term ‘volatility’, with respect to prices, as “tending to fluctuate sharply and regularly”.
Note that there’s no reference to down vs. up in the definition.
The reality is that equity market prices have fluctuated sharply and regularly throughout history.
Since 1980 alone, the S&P 500 Index has experienced the following declines: 27%, 34%, 20%, 19%, 49%, 57%, and 19%. Pretty darn volatile.
Yet, the price of the S&P 500 Index was about 106 in 1980, and it closed 2013 over 1,800!
Volatility vs. Risk
So why are we focusing on volatility?
In my opinion, the biggest fallacy perpetuated by the dominant financial media today, which is causing more long term damage to retirees than anything else, is equating and getting you to buy into the concept that volatility equals risk, i.e. that they are one and the same.
(As a quick aside, their perpetuated fallacy serves their purpose of getting you to tune into and be mesmerized by daily volatility).
Once and for all, volatility is not risk.
Volatility, as defined earlier, is simply rapid price fluctuations (in both directions).
Risk is the measured likelihood of a desired outcome. (please re-read that again)
For you, the #1 risk you face is not that the value of your investments will go up and down over your lifetime.
Not only is that phenomenon not a risk, it’s a virtual certainty.
The #1 risk you face is your investment assets not appreciating fast enough during your lifetime to support your rising lifestyle costs, leading to you running out of money.
Given this, it’s not a luxury in any way for your money to grow. It’s a bare necessity given inevitable rising prices.
Why Subject Yourself to the Volatility of Equities?
The reason we maintain an ownership stake in quality companies, and subject ourselves to the volatility of equity/stock prices, is because they’ve delivered the most effective hedge against rising costs in history, thus allowing their ‘owners’ to maintain their purchasing power, and their desired lifestyle.
In other words, they’re in a class by themselves when it comes to solving the #1 risk you face as noted above. No other asset class even comes close.
And, given that interest rates have no place to go but up, bonds are less likely than they’ve been in the past to do the job in the long term.
Volatility is simply the name we give to the uncertainty of equity investment returns over the short to intermediate term.
However, it’s the long term (your lifetime) that is the risk you face given that the average lifespan of a non-smoking 62 year old couple is 30 years!
Over the long term, as the numbers I shared with you earlier indicate, the historical trend line of equity prices is quite certain.
And, that’s where our focus has to be if we are to effectively deal with the #1 risk you face.
Goal vs. Market Focused
The successful investors in retirement who I’ve witnessed were relentlessly goal-focused.
The unsuccessful ones were anxiously market-focused.
In light of this, if your mix of investments was built in pursuit of your goals, and your goals haven’t changed, then it’s rarely a good idea to radically change the mix regardless of current events.