I was recently reminded about the importance of setting realistic expectations, both in day-to-day life and when investing in share markets.
To put it simply, when expectations are exceeded, we experience happiness and satisfaction. On the contrary, unmet expectations can lead to disappointment and frustration.
So as investors, how can we set our expectations to ensure that we don’t experience a rollercoaster of emotions?
Strap yourself in for short-term volatility
There are so many great quotes relating to share market volatility, but my favourite comes from Morgan Housel, author of the Psychology of Money, who stated:
‘Volatility is the price of admission. The prize inside is superior long-term returns’.
Whilst share market corrections are unpleasant, they actually occur a lot more regularly than you may expect. For example, using the S&P 500 as a proxy, if you had been invested since 1980, on average you would have experienced market declines of 5% or greater four times a year and market declines of 10% or greater at least once each year.
These declines are the sign of a functioning share market and coming to terms with this is one of the most important skills that investors can equip themselves with.
Understand what you are invested in
It’s important to understand how your money is invested and how much volatility you should expect from your mix of assets.
Growth assets like shares will fluctuate on a day-to-day basis, but the longer you extend the time horizon, the more likely you are to experience positive returns.
Defensive assets like bonds and fixed interest will be less volatile in nature, and with that comes a lower expected long-term return.
Take a long-term approach
Warren Buffet famously states that “investing in the share market is simply shifting wealth from the impatient to the patient.”
The journey may not always be a smooth one, but markets have consistently rewarded investors who take a long-term view. The below table is a great example of this. It takes data from the past 35 years and outlines the range of returns achieved by a portfolio of globally diversified shares.
Over the short term, annual returns range from +43.25% to -37.43% (the GFC), but the longer the time horizon, the smaller the range of outcomes.
So the next time you find yourself starting to worry about your portfolio, take comfort in knowing that corrections are part of a functioning share market and that investors who stay the course have been rewarded in the long run.
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