The stock markets have been a rough ride this year. Once again, pundits and people on the street have wondered if it is “different” this time. In reality, everyone is right. Each of us experiences a crisis from a uniquely personal perspective. But, in terms of your investments or retirement account, it helps to remember that volatility is actually the norm for stock markets. Markets never match their average on a year-to-year basis but have historically moved up in what can seem like an unsettling jagged line. The real difference is that today we are experiencing dual crises in healthcare and the economy. This not only affects our pocketbook, it has affected life as we know it. But then again, there have always been major disruptors throughout history. On the positive side, these disruptions have caused us to reevaluate what is important, and society has moved forward more strongly than ever. Investing as we know it, involving the general population, began in the mid-18th century. As the speed and efficiency of information that the markets process has improved, it is important to remember that volatility is a natural by-product. The markets continually reassess performance expectations of the companies they represent. This real-time pricing in risk means that markets tend to behave in unpredictable ways in the short-term. One thing we, as financial advisors, find helpful in managing the emotions generated by uncertainty, is explaining to our clients the difference between saving, investing, and speculation. And why understanding the role of each helps long-term investors stay the course to achieve their important long-term goals.
Saving
Both saving and investing involves setting money aside for future personal goals, but after that, they diverge. Saving does not involve taking risk, so the returns a saver is paid are typically low -- inappropriate for achieving long-term financial goals. Savings are, however, useful for emergencies and specific short-term goals.
Investing
There are many more risks than those generated by the markets. Investors agree to take on additional risk in order to be rewarded by higher returns. How much risk you take depends on your personal situation and goals. But most people are concerned with inflation (not having enough purchasing power in the future) and longevity (outliving their money). By accepting the market risk of investing, they are mitigating other risks that could be more consequential down the road. Given the market volatility discussed earlier, we as advisors, recommend viewing investing as a long-term activity. This means planning on not using the money for at least 5 to 10 years -- allowing time to flatten the short-term volatility.
Speculating
This can be thought of as gambling. It often involves the risk of losing everything for a much higher return. Science has shown that neither speculation nor market timing works to the advantage of the prudent long-term investor. We advise our clients to cover their basic needs and wants with appropriate, well-diversified portfolios of mutual funds and ETFs. Putting extra discretionary money (which they can afford to lose) into riskier investments is appropriate as entertainment. Think of the tortoise and the hare. Making more money faster is not the way to finish your race. Though much has changed, not everything has. The same actions that make investors successful are still true -- invest appropriately using a diversified portfolio, and stay-the-course for the long-term remembering that market volatility smooths out over time