Have you ever noticed that things can become easier the second time around? It is usually because we know what to expect. When we are adequately prepared, we can typically handle situations better than we did the first time.
Parents can probably relate to this. I am a father of three children, the youngest of which is a 3-year old girl. When my oldest children came along (twins), and I was new at this parenting thing, I would find myself getting exasperated when they would not do what I asked them. Was there an error on their part, or did I have unrealistic expectations?
I came to realize an astonishing truth: toddlers don’t come into this world with an overwhelming desire to obey mommy and daddy! Rather than an error in my children’s make up, I had unknowingly developed false expectations where they were concerned.
Experience had shifted my expectations greatly by the time my youngest came along. I wasn’t as surprised when she acted like toddlers normally act. Adapting my expectations to reality helped me to handle these situations better going forward (not perfect, but better). I could also catch myself quicker when I was reverting back to my old ways.
Investors’ expectations work much the same way. When these expectations are misaligned with the reality of how financial markets behave, we may draw the wrong conclusions from events which could cause counterproductive responses.
For example, it is common for investors to look at the long term average return from stocks as an appropriate expectation for how stocks should perform all the time. If that fails to occur, it is often viewed as, “What is wrong with the stock market?” That line of thinking is a clue of where investors may have an expectations gap.
From 1926-2014, US stocks (S&P 500 Index) have produced a healthy compound annual return of 10.12%. However, this very long-term average consists of erratic shorter term returns. During this very same period, stocks produced negative returns in one out of every four years, and two out of every five months. There were 25 “bear market declines” with the average return in these periods of -26%. There were wars, crises, disasters, scandals, heists, and all types of obstacles. High stock returns were achieved through this mess, not by avoiding it.
A successful investing journey needs to begin with this reality in view. We all need to know ahead of time how we will respond when the peaks and valleys occur, not if they will occur. The most extreme peaks (booms) and valleys (busts) do not require greater skill, but greater discipline to execute the plan – and the patience to see it through. Like my parenting, reviewing past experiences can be beneficial.