Crash Course in Market History – Returns and Risk

Tulip ManiaWe save and invest for something in the future. Wrapped up in this are our hopes and fears; our dreams and worries.

Market history can teach us valuable lessons if we are willing to be good students. One problem, however, is we tend to learn “too much” from the recent past and not nearly as much from more distant history.


The Collapse of the Tulip

Organized markets trace back to about the 12th century. As long as we have had markets, there have been speculative bubbles. The 1637 “Tulip Mania” in Europe is among the most famous. Prices for one tulip stem reached the equivalent of about $12,000 before collapsing. Bubbles come and they go – a repeatable pattern.

More recently, technology stocks increased to bubble prices in the late 1990’s. We often remind clients that markets are organic and thus go up and down, not up and up. Bubbles and crashes are inevitable, but the most important market periods are those periods in between.


Weather vs. Climate

Understanding and utilizing the lessons from market history presupposes that we view history in context. This is akin to the distinction between “weather” and “climate”. Our day-to-day “weather” can be volatile, but the longer term “climate” tends to follow patterns that are repeatable over time.

Understanding the long-term “climate” of investing, we know that there is a degree of risk in everything we undertake. We also know that there is a clear connection between reward and risk. There is a reward, in terms of expected return, from bearing risk. The type of risk we are describing is the risk of doing badly in bad times.


The Most Important Keys of Investing

As mentioned above, in our minds, the most recent market troubles carry more importance than longer swaths of market history. This is where creating space between yourself and your investments is crucial. After significant market declines, the previous market levels are regained in fewer than 100 days on average. Half of the decline is typically re-captured in only 11 days.

Your overall investing experience is composed of two main parts: market returns and your personal behavior, or response, to market volatility. The former is freely given, but uncontrollable by us. The latter is within our control. Remember: The reason to invest is for something in the future. Don’t let the “weather” bother you too much.

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