There’s an old story about Peter Lynch buying some stock after he did a ton of careful research on it only to see it get cut in half and then get cut in half again. (The precise numbers don’t matter.) He was dumbfounded but stuck with it. Eventually, it all worked out and he became the legendary fund manager he was.
We’ve been in a bull market for some time now and it’s full of “investors” that have had limited experience with anything else. There is an awareness about “dips” as in “buy the dips!” Usually, that’s expected to be a one or two-day affair before new highs are reached.
The data says that you’re going to see some major declines in your stocks. When I say major I mean more like 50%, not 5%. Declines of that magnitude are very good if you have a long-term investment horizon, high conviction, and are not on margin. If any of those are not true it puts you in a very bad spot.
Lifestyle-changing stock returns are unlikely to come from short-term trading. It’s not impossible but the chance is very slim. If it does come there it’s rooted in a systematic approach that limits risk and allows for consistent small to medium returns.
The really big money comes from the stocks that can appreciate 5x or 10x in a few years. They won’t do it in a straight line. You might face multiple 20%+ drawdowns (or worse) along the way.
Expected Volatility & Returns
If you’re buying into very stable businesses with high profits and dividend yields you can expect the volatility to be less than average. If you’re out there searching for small-cap companies that could appreciate 10x in the next few years you should expect it to be far more than average.
If you expect it you can prepare for it. First of all no margin. Second of all do your research and understand the fundamentals. Finally, think about the holding period and what follow-up actions you can take if the shares do indeed exhibit this level of volatility.
In tax-free accounts, you have the luxury of “trading around” your position without much cost. Selling calls with rich premiums when the shares are being bid up can work well. Or simply keeping the position at a specific % of your portfolio and buying and selling accordingly.
If you have a taxable account buying and holding is going to serve you best. That might mean a smaller stake and/or dollar cost averaging over time. That’s the way I accumulated all the BTC I bought over the last 10 years or so - at $100 per month. It doesn’t buy much now but it did for a while. If it goes down again it will buy more.
Another idea I first heard from my friend Howard Lindzon. If there’s a big market decline and there are 10 companies you really like, treat them like a venture portfolio. Put a set amount of money aside, let’s say $10K and buy $1K of each. Then put them away and don’t bother to look for two or three years.
Plan for big drawdowns because they always come along.