The last three months of 2018 was the worst quarter for stocks in seven years. The first three months of 2019 was the best quarter for stocks in 10 years.
Question: Is that volatility a fee or a fine?
Fees are something you pay for admission to get something worthwhile in return.
Fines are punishment for doing something wrong.
It sounds trivial, but thinking of volatility/drawdowns/uncertainty/pain/terror/ulcers as fees instead of fines is an important part of developing the kind of mindset that lets you stick around long enough for compounding to work.
Few investors have the disposition to say, “I’m actually fine if I lose 20% or more of my money.” This is doubly true for new investors who haven’t experienced a 20% decline.
But a reason declines hurt and scare so many investors off is because they think of them as fines. You’re not supposed to get fined. You’re supposed to make decisions that preempt and avoid fines. Traffic fines and IRS fines mean you did something wrong and deserve to be punished. The natural response for anyone who watches their wealth decline and views that drop as a fine is to avoid future fines.
But if you view volatility as a fee, things looks different.
Disneyland tickets cost $100. But you get an awesome day with your kids you’ll never forget. Last year more than 18 million people thought that fee was worth paying. Few felt the $100 paid was a punishment or a fine. The worthwhile tradeoff of fees is obvious when it’s clear you’re paying one.
Same with investing, where volatility is almost always a fee, not a fine.
Returns are never free. They demand you pay a price, like any other product. And since market returns can be not just great but sensational over time, the fee is high. Declines, crashes, panics, manias, recessions, depressions.
You’re not forced to pay this fee, just like you’re not forced to go to Disneyland. You can take them to the local county fair where tickets might be $10. You might still have a good time. But you’ll usually get what you pay for. Same with markets. The volatility/uncertainty fee is the cost of admission to get returns greater than low-fee parks like cash.
The trick is convincing yourself that the fee is worth it. That, I think, is the only way to deal with volatility; not just putting up with it, but realizing that it’s an admission fee worth paying.
There’s no guarantee that it will be. Sometimes it rains at Disneyland.
But if you view the admission fee as a fine, you’ll never enjoy the magic.