Stocks, Volatility & Expectations

I'm realizing lately that stocks and toddlers have a lot in common: They both go through phases, and those phases don't last forever.Judy is my second-born, almost-two-year-old daughter. Everyone calls her “Juju”, and sometimes she seems like a happy, cooperative little angel. She'll sleep through the night, clean her plate at every meal, giggle in the tub while we wash her hair, and generally seem like a perfect little Gerber baby.But she’s our second child, so we know these idyllic moments are probably part of a passing phase. It may only be a few days before the clouds gather and the weather turns, and then we’ll be in the thick of it: Bathtub tantrums, hunger strikes, 2am wake-up calls, you name it.With our first daughter, these reversals seemed devastating. Every time she transitioned from an “easier” phase to a “harder” phase, we felt like she was going backwards. Even worse, we felt like there was something wrong with her -- or with us.But experience and lots of advice from friends and family helped us see that raising children is an ongoing series of “two steps forward, one step back” developments. While their long-term trend seems to be consistent growth and positive development, they’re up and down in the short term.When we regularly remind ourselves that Juju will be changing all the time, it’s much easier to adjust to those transitions when they come.Stocks are like toddlers: They go through phases, and those phases don’t last forever.Stocks were unusually cooperative between November 2016 and February 2018. They climbed steadily up without their usual levels of daily, weekly or monthly price fluctuations.This was a pleasant but conspicuous anomaly. As I wrote in March, the data shows that market volatility is the norm, and stable growth is the exception.Looking back, that 16-month stretch of calm, steady growth seems like the investing equivalent of your kid doing everything you ask her to do… for almost a year and a half.    “Get in the bath? I love baths!”    “Get dressed for school? Sure, mom!”    “Turn off the TV? No problem -- I wanted to play quietly with my toys, anyway!”If either of my girls was that cooperative for that long, I would really enjoy it. And I would appreciate it. But I wouldn’t expect it to last forever.As investors, it’s imperative to adjust our expectations and accept the market for what it is -- a volatility machine.It’s also important to remember that volatility is the main reason why stocks consistently provide a higher rate of return over the long term than safer asset classes like bonds.The markets are going to go up and down. Now that I’ve beaten this point about volatility into the ground, let me pivot toward how to incorporate it into your personal investing strategy. Speaking in very broad terms:

• If you have two or three decades until retirement, you can use volatility to your advantage by buying stocks during market downturns (in the business we say, “buy the dips”) and hold them for the long term.
• If you don’t have a long time to ride out potential declines in the stock market, you may want to consider pruning back your overall allocation to stocks after prices rebound (i.e., “sell the rallies”), and move the proceeds into something with more short term stability.

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