I entered the investment business around the turn of the century. The economy was headed for a recession fueled in part by excess speculation around this new thing called the internet. I have been taught ever since at the “school of hard knocks” offered to any investor by the market itself. I thought I would share a couple of observations and lessons from my schooling.
Lesson #1: The future is hard to predict. People are just bad at predicting the future. Just today I saw a headline that said, “Fed officials see higher risks of inflation.” Yes, the same Fed officials that completely missed the inflation risks of 2021 and 2022. Now, I’m not suggesting that you shouldn’t have opinions about the future and there can’t be value in trying to see what new opportunities are available. But predicting when and where they will occur gets tricky and your risk of being wrong skyrockets. When someone tells you in great detail what will happen in the future, accept their advice with a very large grain of salt.
Lesson #2: If your advisor tells you to invest by “avoiding the volatility of the stock market,” you should ask some hard questions. You shouldn’t invest money that you need in the near future due to lesson #1 above. If you do, you take a risk that your timing will be poor. The flip side is also true. The longer your timeframe, the odds of a successful investing outcome rise significantly.
When someone focuses too much on volatility, they miss the whole point of investing. Investors who buy stocks get paid an “equity premium” for dealing with the uncertainty and volatility of the market. In a capitalistic economy that is heavily incentivized, good companies are lethal at solving problems.
Wall Street has created many products that offer to suppress volatility. We call them things like “market neutral funds” and “long/short funds”. The annual trailing return on the Vanguard Market Neutral Fund (VMNFX) over a 10-year period is 3.22%1, whereas the Diamond Hill Long/Short Fund (DIAMX) has returned 5.89%1 annually. Over the same timeframe, the S&P 500 (SPY) earned 13.24%1 on average. Which fund was down the most in 2022 (the most recent negative market year)? The S&P 500 of course! It dropped by 18%1 in 2022, far more than the volatility suppressor funds. But unless I needed to spend that money, did that short-term drop in value actually matter? Probably not. If you started with $10,000 invested in each of the above funds, you’d end up with $13,749 in the Vanguard market neutral, $17,355 in the Diamond Hill long/short, and $33,969 in the S&P 500 option. Over the last 10 years for sure, volatility pays! This would only magnify over a longer period of time.
We strive to help clients build portfolios to weather short-term downturns while maximizing the long-term potential of their money. We embrace the volatility. It’s what gives you the ability to far outperform the fancy sounding tools of Wall Street. When you hear less volatility, think less returns too.
1 All data sourced from Morningstar as of 2/19/2025.
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The opinions expressed are those of PYAW’s Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed. This material is for informational use only and should not be considered investment advice. The information discussed herein is not a recommendation to buy or sell a particular security or to invest in any particular sector. The Standard & Poor's 500 Index, widely referred to as the S&P 500, tracks the performance of 500 widely held large-cap US stocks in the industrial, transportation, utility, and financial sectors. Indexes are unmanaged, do not incur management fees, costs, or expenses and cannot be invested indirectly.
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