David offers 4 rules-of-thumb to help you keep your head in a volatile market. And a couple of bonus tips to help you win bets at the ballgame!
Rule Breaker Investing
Coping with a Volatile Market
It's the Rule Breaker Investing Podcast with Motley Fool co-founder, David Gardner. And welcome back to Rule Breaker Investing. I'm David Gardner. Thanks for joining me during this most volatile of market weeks. I've kind of pushed aside my normal agenda this week for Rule Breaker Investing and let's make the podcast speak to the market a little bit in what's happening in the world at large. As I tape this and I'm taping this on the morning of Tuesday, August 25th, the three previous days the market had declined about 4% or so each day, at least my portfolio had, which I care a little bit more about than the market. So that's a really bad string of three consecutive 4% losses. And then as I taped today, the market's up about 5% bouncing back. So this is an extremely volatile week and it's probably the most frequently asked question that I get not just this week, but every week, any given week at a cocktail party, social occasion, maybe you get this too, people ask, "Hey, what do you think of the market? Where's the market headed? What's the market going to be doing?" Since I don't really have any intelligent answer to that question, what I've learned over the course of time to do is largely to ignore the question and talk not about what the market's going to be doing, because it will be doing something. I'm just never sure what it will be doing, but instead to frame it up as a few rules of thumb that I'm going to share with you this week. I have four rules of thumb when I think about the market. And let's kick it off right now with number one and number one rule of thumb about the market is that one year in three, the stock market declines. That's a pretty time-tested ratio over the last 100 years. If you go back, you'll see about 60, 65 of those years, the stock market is up. And about 35 of those 100 years, the stock market is down for the year. Quick sideways rant. Often when people talk about the market declining, whether it's this week or perhaps this year or the last year that the market declined, they use the word correction. My mini rant, I don't like that word. It implies that things were incorrect as the market rose. And so we're always talking about the market going down as being correct or correcting. I don't think that's a proper way of thinking about the market. I think if we're really thinking about corrections, presumably the market would be correcting upward just as often as it might be correcting downward when the market had a dramatic 70% decline, the S&P 500 down more than 50% in 2008 and I guess we corrected back up in the subsequent five or six years that we've watched the bull market run. But to end this sideways, insert rant, I don't think the word correction is the right word that we all should be using. Regardless, rule of thumb number one, always remember that one year in three, the stock market actually declines. Rule of thumb number two, despite rule of thumb number one, the stock market has averaged approximately a nine to 10% gain annualized over the past century. That's a really important rule of thumb. That rule of thumb reminds us that there's probably no better place for your money or my money if we're invested for three plus years, I hope 30 plus years, there's no better place for that money to sit than the stock market. Bonds have returned six to seven percent, certainly simple interest bearing devices like bank accounts more like one to three percent inflation, around two to three percent historically, there is no better place than the stock market for your money. So you have to remember that despite those one year in three where things go down, the media reports on it, we call it a correction and despite all of that, take it all in all, you're gaining nine to 10% a year. I saw a headline earlier this week on a news service that said something like, I'm paraphrasing, millennials will pay for not liking stocks, experts say. The point of the article was that the stock market doesn't appear attractive to many so-called millennials because they either doubt it or they've seen some of the big bad market years, 2001, 2008, nine growing up and there's not a lot of financial education still in our schools about the stock market. And so the idea is that if you are young and you are distrusting of the stock market, you're going to end up paying quite an opportunity cost. And I think we understand what that would be rule of thumb number two, nine to 10% annualized gains compounded over time. Rule of thumb number three, rule of thumb number three is more about you and me than it is about the market, but it's important to remember in the context of the market and talking about the market and that is that you and I should expect to be wrong at least a third of the time when we're talking about anything from our feelings about the market or our confidence in a given stock pick or almost any financial prediction that I'm hearing made all the time. But we're talking this week about the market. The best people in the world are right about two times in three. So you have to always reserve the right to know that you're going to be wrong one time in three. That's why I don't spend a lot of time trying to predict the market myself. I would probably be more like a coin flip on this one, not one of the best people in the world that call in the market who will be wrong one third of the time. For these reasons, I encourage you rule number three encourages us not to spend a lot of time listening to people who are making predictions about the stock market or a given stock. It also reminds us to always be humble and realize that if you have a stock market portfolio, your number one holding or your number one highest confidence pick, you will be wrong at least one time in three. For those reasons, we should do things like diversify, not load up too much on any one pick, not have too high degree of confidence that a given stock or the market will do what you're hoping it will over the next year or three. And finally, rule of thumb number four. I'm going to start with quoting one of my favorite authors, F. Scott Fitzgerald. This is an often quoted Fitzgerald line. This comes from his novel, The Crackup, in 1936. He wrote, "The test of a first rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function." We're all about trying to gain first rate intelligence in our Rule Breaker Investing podcast. That's what I'm trying to achieve. That's what I'm trying to confer and convey to you. Let's go back over that line once again. The test of a first rate intelligence is the ability to hold two opposed ideas in the mind at the same time. I'm about to give you two opposed ideas that apply to the market for Rule of Thumb number four. If I end up at the end of my career with some legacy lines attributed to me, this I hope will be one of them. I've set it for years and I'm going to continue to say it for years. It's a really important concept. Here it is. The market always goes down faster than it goes up, but the market always goes up more than it goes down. Those are opposed ideas. Let's start with the second part of that line. The market always goes up more than it goes down. Well, that's pretty obvious. Anytime you have something that's gaining nine to 10 percent per year over a century, you can expect that's going to go up. Indeed, the market is doing not much more than reflecting the growth of innovation, technology, wealth, worldwide over the course of the last century. That's why I have great confidence in the market of the next century because we will all continue to grow and to prosper together. Great businesses will come along. More great entrepreneurs will start things you and I can't dream of and add value to the world. That's what's happening with the stock market. The market always goes up, of course over time, more than it goes down, but what's the first part of the line that I just delivered to you? The market always goes down faster than it goes up. That's really important to keep in your mind both of those thoughts, especially during a week like this one. I can't think of any portion, anytime in my investment career, when on three consecutive days, my stock portfolio rose four percent. That just doesn't happen. You might have one great day here or there, but the idea that over the course of three days, somebody would gain 10, 15 percent of their net worth thanks to just market gyrations. I've never seen that happen and yet it just happened on the downside. I've also never seen a stock market in one day gain 20 percentage points or more, but yet that did happen in 1987 on the downside. The market always goes down faster than it goes up. That creates a lot of fear among people. It also is a great headline generator, a lot of clickbait headlines across the internet and newspapers for years talking about fear around the market and the market going down. We all know that fear sells. Maybe that's part of the reason, by the way, that a lot of people who don't pay much attention to the stock market distrust it, because their experience of the market is during weeks like this where we all hear about fears and global fears around the stock market and stocks declining, but since we never have those big up days in a row or those dramatic gains, people kind of miss that that's the norm and that's why the stock market is the best place for your money to be. The stock market always goes down faster than it goes up, but it always goes up more than it goes down. That's my most important rule of thumb, rule of thumb number four. And to close out this week because I love rules of thumb and I also love baseball and part of rule breaker investing is that we can pull in a motley array of ideas and concepts. Let me just close with a couple of my favorite baseball rules of thumb here as the baseball season draws to a close. I realize not everyone's a baseball fan, but I am. So here's a here are a couple of fun ones that most people don't know. Rule of thumb, baseball rule of thumb number one to close two times out of every three, the team that scores first in a major league baseball game will win the game. So if you're attending a game sitting there with your friend, whoever scores first, if you want to place a quick side bet with your friend, you'll now know now that the odds are that two thirds of the time you'll be right that team that scored first will win the game. And here's the second one and this one is less intuitive and therefore an even better side bet with a friend. In two out of three major league baseball games, the team that wins scores more runs in one inning than the opponent scores for the entire game, two thirds of the time in major league baseball. So thus much for rules of thumb here in late August, 2015. Let me quickly review my non baseball rules of thumb to close number one. One year in three, the stock market will and does and has declined. Number two, despite this, the market averages nine to 10% annualized gains over decades. Number three, we should all expect to be wrong at least one third of the time. And finally, number four, the market always goes down faster than it goes up, but it always goes up more than it goes down. Thank you for joining me this week for Rule Breaker Investing. I'm David Gardner looking forward to next week hoping for a little bit less volatility. Till next time. As always, people on this program may have interest in the stocks they talk about and the Miley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. Learn more about Rule Breaker Investing at RBI.Fool.com. [MUSIC] [BLANK_AUDIO]