Look at That Yo-Yo | Or Don't

Market volatility is back and with it comes nervous investors. The VIX (a commonly used measure of stock market volatility) increased this quarter from the low teens to a high in the 30’s as concerns about Chinese economic growth, oil prices, interest rates, and a potential Puerto Rican default have depressed the overall market sentiment. During these times I believe it is critical for investors to focus on their long term financial goals and leave the trading to others.

Consider the following analogy. The stock market is like a man going up an escalator playing with a yo-yo. Although the yo-yo goes up and down, the escalator gradually and slowly heads up. The yo-yo in this example is the short term movements of the market. Traders and gamblers buy and sell based on whether they believe the yo-yo will continue down, or go back up.

Investors, on the other hand, should focus on the escalator which is like the stock market in the long run, and historically moves higher over time. The temptation for investors is to focus on the yo-yo and forget they are on an escalator. It is easy to see stocks decline and conclude that they will continue to fall. If that is the case, the logical step is to sell. Although this approach may seem rational, it is quite emotional. Selling out of fear because you are focused on a yo-yo is a mistake that small investors make repeatedly.

How about the escalator?

I like to say that investing money in mutual funds is like planting grass. If you watch the grass after you plant it, there doesn’t seem to be any growth. Go on vacation for a couple of weeks and check that same lawn and you better grab a mower, assuming of course you don’t have a gardener.

The history of the stock market clearly illustrates the benefits of holding through periods of crisis. Even investors who could miraculously predict the stock market decline in 2008 would have to ultimately find the right time to get back in. If you’ve listened to the news over the past six years you’d realize there was never a news story telling you it was the right time to buy.

In fact, the economic news has been generally bad. The stock market, however, has exploded from a low on the S&P 500 of 666 to a recent high over 2100! The yo-yo may be entertaining. It may make for great daily news. It is a very poor instrument to focus on when managing a long term investment strategy