Here are two doors you can walk through:
Door number one — you spend 15 years putting $1000 into an investment every month, with the possibility of seeing that investment get cut in half twice.
Door number two — you spend 15 years putting $1000 into an investment every month, with the same annual performance of what’s behind door number one, but no drawdowns.
Which would you choose?
On the surface, you’d choose door number two. Of course you would, who wouldn’t?
But it’s the wrong choice. The trick here is to remember that you’re adding to the investment at a rate of $1000 per month. That’s when you realize that door number one, with it’s twin 50% crashes, is the better option.
It’s the harder choice to live with, of course, but that’s what the money’s for. Had you done this over the disappointing period for stock returns between 2000–2014, you would have lots of money to show for your troubles. Much more money than had you chosen the steadier option.
Josh here — The magical part is that the two investment choices both did around 4.1% annually on average. But by taking advantage of the short-term declines — systematically (which is the key) — investors can learn to embrace the volatility that ends up punishing some, but rewarding others with higher than average returns.
Conditioning yourself to love drawdowns is not easy — and the more money you have at risk, the harder it is.
Don’t flee from volatility, understand how it helps you.
Written by Kalen
Buddhism, mixed with my current interests in economics, privilege, immigration, etc. Email <my username>@gmail.com