By Viram Shah
2021 was a banner year for US markets with the S&P 500 returning almost 27%. However, markets have been volatile in 2022 and YTD returns for the S&P 500 have been negative 22.51% as of September 23, 2022.
The figures above tell us something fundamental about the stock markets. While there may be a year where you get returns of more than 20%, the markets can lose value by 20% in a short period. Times like these, when markets are volatile, urge us to learn critical investment lessons. Here we look at some key lessons about investing in the US during the good times and the bad.
Stocks are volatile
The most important lesson, which seems obvious but is often overlooked, is that stocks are risky. Investing in stocks carries inherent volatility. And at the same time, they are the most rewarding. By investing in the stock market, you bet on how a company will perform over the next five to ten years. So, there is an element of uncertainty. To earn a return, you must be willing to accept a certain amount of risk. It usually follows that the more risk you are willing to take, the higher the possible return. But there is also the possibility that you will lose money.
Average return is not the norm
Since its inception, the S&P 500 has returned 11.82%. In 20 years (from 2001 to 2021), the average annualized return has been 9.87%. Over the long term, stocks have given an average return of 8-10%.
However, the lesson here is that ‘average’ is not the norm. In most years, the returns are anything but average. We have seen how the market returns have been different in 2022 compared to 2021. In 2017 and 2019, the S&P 500 had given returns of 21.61% and 31.21%, respectively. During 2001 (during the dot-com crash), the S&P 500 fell 11.85%, and in 2008 (during the great recession), the S&P 500 fell almost 37%!
Therefore, it is essential to keep in mind that very high returns in the stock markets are not sustainable. If one wants to reap the benefits of stocks, one must accept the volatility that comes with the markets. While it may not be easy to watch your investments fall, acknowledging the moody behavior of Mr. Market (a term coined by legendary investor Benjamin Graham) is an important lesson for investors.
Also Read: Does US PMI Data Indicate Better Days For US Stock Market Investors?
Invest for the long term
You should invest in the stock markets with a sufficient long-term horizon. If you’re investing short-term (for a year or less), you’re at best estimating whether your investment will go up or down a year from now. Most investors lose money because they invest with a short-term horizon.
Know where you invest
Before investing in stocks, you must have adequate knowledge about the company and the industry. Making an investment based on what your friends are investing or a top tip on social media is likely to backfire. If you want to invest in a company that is in an industry you don’t understand (for example, genomics), you can invest through an ETF.
Also read: Earnings growth of S&P 500 companies in the next quarter will be in the spotlight from now on
Finally, your investments in the US stock market should be properly diversified across different asset classes, sectors and industries. For example, if your portfolio is concentrated in high-risk health care or technology stocks, you can lose money when these sectors underperform. Investing lessons are like lessons on how to stay fit. Whether it’s a boom cycle or a bust cycle, following them will help you a lot.
(The author is co-founder and CEO of Vested Finance)