When highly successful people like Warren Buffett and John Bogle tell investors to stop worrying about the noise or volatility in the market, do they know what they are talking about?
Let’s put this into perspective. I am sure you have heard of the question that if a tree falls in a forest and there is no one there to hear it fall, will it still make a sound?
I can hear you saying, ‘yes, of course it will make a sound’ and you are correct.
So what happens when 5 trees fall at the same time or if 100 trees fall and no one is around? Let’s liken this to an investor who has a small portfolio of stocks and bonds. In this case, if this portfolio can be compared to the one tree, when it falls, it will be a big deal. On the other hand, if you have a very big stock portfolio or the whole forest of trees, when a few scattered trees fall around the forest, the impact will be far less. In fact, you might not even notice some of these trees falling among all the trees in the forest.
According to John Bogle, who is the founder of Vanguard Group, if you want to be a successful investor, you need to understand that you don’t need to always react when a tree falls down. The fact is trees fall all the time in the same way that prices in the markets move up and down all the time. Bogle commented that when investors hear and see this constant movement in the markets, they feel the need to react. Instead, Bogle says an investor does not need to do anything at all but to accept that volatility is part and parcel of financial markets and should be ignored.
As Bogle said, "Don't pay a lot of attention to the volatility in the market place. All these noises and jumping up and down along the way are really just emotions that confuse you."
The fact is one’s investments are likely to move up and down and all investments carry risk. To be able to control one’s emotions regarding these risks as well as the market movements or volatility, it is vital then to find a balance between a portfolio that produces a compounding and steady return while also reducing the number of emotional reactions one might have to market volatility which can negatively impact one’s investment.
In a recent letter to his investors, Warren Buffett also spoke about volatility and risk. Buffett said that most investors think that volatility causes risk which is not accurate. As Buffett stated, “Volatility is far from synonymous with risk". By thinking the two are linked, investors make emotional and irrational decisions which negatively impact their investments.
With that said, the fact is risk and volatility can be compared to 2 sides of a coin which never touch yet are related. On the one side, risk can be viewed as the negative side as it holds the possibility that we could lose something. But the reality is we live with risk daily and if we were not able to survive with this risk, then we would never leave our homes. Instead, we have learnt to reduce this risk by for example air bags, seat belts etc.