Volatility: The Justifiable Price We Pay for Returns

Statistically, as we noted in our most recent issue of The Nexus Report, the S&P 500 suffered its worst December performance since 1931, only to be followed by its best quarterly performance in 10 years (when it was then rising from the depths of the financial crisis of 2008/2009.) Based on our discussions with clients, it was the most difficult emotional period in some time as well.

But in hindsight, all that really occurred was a quick little “round-tripper” – the sort of sharp change in value that is normal, but elevates investor anxiety while it is happening. Many see such market volatility as a risk to their investment returns. They think of it as a penalty, and something to be avoided. However, it might be easier to accept if you “reframed” these sorts of periods as a justifiable fee – the price of admission, if you will, that we all pay for returns.

Recently, a long-standing Nexus client pointed out an article that suggests that volatility should be looked at more as a fee than a fine (read it here). The author, Morgan Housel, points out that each year, 18 million people think that paying a $100 fee to get into Disneyland is well worth the price. In an analogous fashion, when an investor is prepared to think of volatility (and other market-induced, short-term nastiness) as a fee, then it helps them concentrate on the benefits of holding on for the long term. If instead they view such bouts of market disruption as fines, then a different and less helpful cognitive behaviour kicks in. People dislike paying fines and so assume a state of mind that tries to avoid paying them. In the investment world, that means trying to avoid volatility and fluctuations which naturally occur on the road to long-term success.

Interestingly, this is the sort of article which normally travels from an investment manager to a client as a discussion starter. In this instance, though, the article was sent along to us by a client – one with close to 40 years of capital markets experience and who understands that long-term investment returns don’t come without some bumps along the road.

At Nexus, we consider market swoons as fees, not fines. We accept that in exchange for paying the fee, we will get good value in terms of realized positive long-term returns. But like everyone these days, we too want lower fees! So, we have an investment approach which is designed to smooth out the naturally occurring periods of market retrenchment. Specifically, our emphasis on quality is designed to preserve capital in down markets. But we recognize that some declines are inevitable and unavoidable.

Sometimes looking at things in a different light makes them easier to accept. I recently received the shingles vaccine. I wasn’t particularly pleased with the cost, the poke in the arm or the slightly unpleasant side effects… until, I considered the alternative!