As a soccer rules-challenged dad of a somewhat undersized third grader, I was more than alarmed at seeing him on the ground during a recent game after a scary mid-field collision. I was angry. That couldn’t possibly have been a legal move the other kid put on him.
After checking that all of his limbs were still intact and moving mostly in their proper directions, I asked the coach about the play and found out that what the other kid did was completely within the rules.
To the uninitiated, the stock market can sometimes feel unfair as well—and scary. As the market jolts up and down, you wonder whether the floor is going to completely give way. Aren’t there any rules that govern how rough the ride can get?
Of course, there are rules that draw the line between what’s legal and illegal. Even within the vast legal universe, where most investors ply their trade, there are certain unofficial rules that govern the market. Call them historical patterns, operating principles, or simply how things work. Understanding them can make a huge difference to your confidence as an investor, and your success.
One of those principles is that the path toward the market’s year-end performance number is rarely straight or smooth.
Of destinations and journeys
Many a motivational poster has been designed around the theme that the journey matters more than the destination. Of course, they both matter, but if anyone tends to be overly focused on the destination, it’s newer investors. They see that the market’s average annual return since 1926 has been 10% and they want in. But then their investments have the audacity to lose money one year and they wonder what they missed in the fine print.
While the market’s long-term trajectory has, indeed, been upward, it has treated investors to some interesting side trips along the way. In order to read the investing map, one of the key terms in the legend we need to understand is the prefix, “intra.”
Intraday changes. On October 10, 2008, the Dow Jones Industrial Average plummeted nearly 700 points in the first five minutes of trading. It then went on to recover much of that loss, ending the day down a mere 128 points. The day’s more than 1,000-point spread between its high and low was the Dow’s largest intraday point swing in the past 25 years.
Not every day is that exciting, but every day does tend to have its ups and downs. The S&P 500's 50-year average variance between the day’s high and low is 1.47%.
Intrayear declines. At one point in 2013, a year that ultimately saw a 30% gain in the S&P 500, the index had declined 6% from its eariler highs. At that point, I wonder how many investors were worried about it falling further.
In 1987, a year that saw a sickening 34% drop at one point, the S&P 500 bounced back with a 10% gain off the lows to finish the year with an overall gain of 2%. I wonder how many headed for the exits before the 10% recovery?
The importance of getting up after getting knocked down
As for our third-grader, it’s been a few weeks since the incident I mentioned at the beginning of this article. He hobbled around for a few days with a sore knee, all the while eager to get back on the field. Already I see him playing more confidently. He’s learning when to be aggressive and when to back off. Understanding more about how the game is played is making him more effective and adding to his enjoyment. Mine, too.
Ideally, that’s how investing should work as well. The longer we travel the path of an investor, the more we understand how things work. And the more we understand how things work, the more confident we become in the heat of battle, and the more successful.
What are some of the key lessons you’ve learned as an investor—perhaps the hard way—that have made you more successful?