It is an immutable law of investing in that in order for an investment to provide a higher rate of return in the long run there must be some risk of loss in the short run.  While most investors accept this intellectually, there is still a part of the brain that seizes up and refuses to confront the fear of loss. Since we are wired as humans to avoid things which may cause ruin, this fear has a power well in excess of the actual harm that will be suffered if it comes to pass.

The great Seth Godin reminds us that the type of fear that keeps us from doing important things (health, family, wealth) will never go away. The good news about fear, he says, is that you can learn to dance with it.

How to dance with your investment fear

We see this fear in investors every day. Over time, several factors permit investors to dance with their fears rather than succumb to them.

Invest every day.

Ok, maybe not literally “every day” but regularly and often. Working people do this through their 401k retirement plans and perhaps also with an Individual Retirement Account (IRA).  Broadly diversified and inexpensive index funds such as the Schwab Total Stock Market Index fund give exposure to the entire market (see below) for a paltry 0.03% annual cost and no transaction fees for Schwab account holders.  Many other companies offer inexpensive, broadly-diversified funds as well.

Buy the whole market.

We know for a fact that many public companies will fail. We also know that many will succeed beyond their wildest dreams. Accept the idea that we don’t know which is which. Accept also that some of today’s biggest successes will be tomorrow’s failures. Consider this list of the largest U.S. companies from 40 years ago. Several of these companies subsequently went bankrupt (GM, Chrysler) while many of the companies on today’s list either didn’t exist or were a tiny fraction of their current size.  With this uncertainty, an investment in the S&P 500 on New Year’s 1978 returned 11.8% annually over the subsequent 40 years. That’s enough return to grow a $10,000 investment into $866,307 over that time.

Embrace the volatility.

Although they are expressed as similar, clients of ours know that volatility and risk are not the same thing. Volatility gives us more chances to buy more shares at a lower cost. (Note: if you’re retired, volatility has a completely different meaning which we will address another time). It also gives investors the chance to rebalance portfolios and take advantage of the fact that not all asset classes have the same returns at the same time.  Our clients have heard us say many times that when buying stocks, volatility is a feature and not a bug.

Know what’s really risky.

In our world, there are two types of risk to fear:

1. permanent loss of capital
2. having insufficient income or assets to maintain your lifestyle for as long as you live.

We address the first part by being thoroughly diversified. We address the second part by understanding a family’s need for cash flow and how it changes over time. When this cash flow aligns with your goals and dreams for your family it’s a beautiful thing to behold. We would like to be able to tell you that assets can grow to provide for enduring wealth over time without dealing with volatility but it just isn’t so. If it were true then everyone would be doing it.

Building an investment plan to address these fears is like exercising a part of your body that isn’t used to it. It may seem strange or even painful at first but later muscle grows and the movements become more natural. It may even feel good. The transformation begins when we decide we’d rather dance than sit alone with our fears.