Most successful investors credit discipline with helping them to profit where others don’t. Certainly, in my experience, discipline has been a critical component of successful investment results.
The recent market declines and volatility can be disconcerting and can encourage a lack of discipline. The following charts offer a useful perspective on volatility when viewed through two different lenses. Hopefully, they will help you put the current market volatility into context.
Both charts compare the return of the stock market to the return of risk free treasury bills. This is done by subtracting the return of treasury bills from the return of the market thus calculating a risk premium. The premium is then plotted on the chart.
In the first chart, you can see that the market premium is very volatile when considered on a monthly basis. Recently, some months like October 2011 have offered investors very high returns (11.5%) relative to treasury bills while others like October 2008 offered very low returns (-18.6%) relative to treasury bills.
Interestingly, there doesn’t seem to be a pattern. The returns are essentially random. The implication is that to earn the returns, you must be invested.
The next chart takes a longer-term (5 year) perspective on the data. This has the effect of smoothing the monthly zigs and zags of the market. For sure, there are still periods when the markets return less than treasury bills (red bars) but the chart doesn’t look as scary does it?
Crucial Takeaway: The key to being a successful long-term investor is perspective and discipline. That doesn’t mean that it’s wrong to be uncomfortable during periods of market stress. Instead, it means there is a huge advantage in using perspective to maintain discipline and thus achieve your long-term investment goals.