When I was just a kid, the county fair came to town. My friend and I really wanted go to. But we didn't want to pay to get in. So we concocted what we thought was a brilliant strategy to get in for free.
We wanted to get something for nothing.
We had heard of other people doing it.
We thought we were smart.
We believed we could do it.
To this day I don't know where he came from, but not even ten seconds after hopping over the fence, a police officer pulled around the corner and stopped us. We got busted. Not only did we have to pay the admission fee, we each paid an arguably higher price once we got home!
Successful investing, just like everything else, has a price. But that price is not in dollars and cents. The price for successful investing is volatility, fear, doubt, uncertainty, and sometimes, even regret. The inability to recognize that investing has a price can tempt us to try and get something for nothing .... which is pretty much like shoplifting. Or trying to get into the fair for free. Some people get away with it. The vast majority don't.
Consider this: The S&P 500 increased almost 200-fold in the last fifty years. What’s even more amazing is what you had to do to realize those returns—pay the admission fee. Accept the fear, uncertainty, and doubt. And then, you just had to sit there and watch your money grow. That’s right. All you had to do was nothing.
Sounds easy, doesn’t it?
That's because successful investing often sounds easy when we’re looking in the rearview mirror. But it’s more difficult in the present moment, when we’re looking at a future that seems so uncertain. Uncertainty is scary.
To help navigate uncertainty, it can help to view volatility and all the emotions tthat come with it as an admission fee. Imagine you want a new car that costs $60,000. You have three options: 1.) Pay $60,000 for it. 2.) Find a cheaper used one. 3.) Steal it.
In this case, 99 percent of us know to avoid the third option because the consequences of stealing a car outweigh the upside.
Now say you want to earn 9 percent annual rate of return over the next 20 years so you can retire comfortably. Or maybe you’re retired and you want to earn 5 or 6 percent to maintain your lifestyle in retirement. Does this reward come free? Of course not. There is a price that needs to be paid. In this case it’s a never ending taunt from the market, which gives big returns, and then takes them away just as fast. This volatility is the price of market returns. It’s the fee, the cost of admission. And it hurts.
Like the car, you have a few options: You can pay the price, accepting volatility and the big ups and downs in the market. Or you can find a portfolio with less uncertainty and a lower payoff. Or you can attempt the equivalent of grand theft auto and try to get the return while avoiding the volatility that comes with it. It’s ultimately your choice.
Many investors choose the third option. And like the car thief, they form tricks and strategies to try to get the return without paying the full price. They buy and sell, buy and sell. They attempt to sell before the next recession and buy before the next boom. Some car thieves get away with it. Many more will be caught and punished. It’s the same with investing.
Morningstar looked at the performance of professional money managers who use the strategy I just mentioned –trying to minimize losses and maximize returns without paying the full price of admission – volatility. The study focused on the U.S. markets from mid-2010 to late 2011 when U.S. stock markets went crazy on fears of a new recession. U.S. stocks declined by more than 20%, the exact environment these types of managers are supposed to do well in. Out of the 112 money managers analyzed during this period, only nine had better risk-adjusted returns than a simple 60/40 stock-bond fund.
Individual investors fall for this when making their own investment decisions too. … The irony is that by trying to avoid the price, investors end up paying double.”
Why do so many intelligent people, all of whom are willing to pay the price of cars, houses, food, and vacations, try so hard to avoid paying the price of good investment returns? I think it’s because the price of investing success is not immediately obvious. You can’t see the price tag, so when the bill comes due, it doesn’t feel like a fee for getting something good, it feels like a fine for doing something wrong.
Market returns are never free and they never will be. They demand we pay a price just like for any other product. You are not forced to pay the fee, just like you’re not forced to go to Disneyland. Just like everything else, you get what you pay for. The volatility and uncertainty fee -the price of returns—is the cost of admission to get returns greater than low-fee parks like cash and bonds.
There’s no guarantee that it will be worth paying. Sometimes it rains at Disneyland. But if you view the admission fee as a fine, you’ll never get to enjoy the magic.
It may seem trivial, but thinking of market volatility as a fee rather than a fine is an important part of developing the mindset to be a successful investor.