The saying, “The market hates uncertainty” has been a common enough in recent years, but how logical is it?
There are certainly many different aspects to uncertainty, some that can be measured and some that cannot.
Uncertainty is quite simply an unchangeable condition of our existence.
As individuals, we can feel more or less uncertain, but that is a distinctly human phenomenon.
Rather than ebbing and flowing with investor sentiment, uncertainty is an inherent and ever-present part of investing in capital markets.
Any investment that has an expected return above the prevailing “risk-free rate” involves trading off certainty for a potentially increased return.
Consider this concept through the lens of bonds versus shares otherwise known as equities.
Shares have higher expected returns than bonds largely because there is more uncertainty about the future state of the world for shareholder investors than bond investors.
Bonds, for the most part, have fixed coupon or interest payments and a maturity date at which principal is expected to be repaid. Shares have neither.
Bonds also sit higher in a company’s capital structure. In the event a company goes bust, bondholders get paid before shareholders.
So, do investors avoid owning shares in favour of bonds as a result of this increased uncertainty? Quite the contrary, many investors end up allocating capital to shares due to their higher expected return.
In the end, many investors are often willing to make the tradeoff of bearing some increased uncertainty for potentially higher returns.
Now onto managing emotions...
While the statement “the market hates uncertainty” may not be totally logical, it doesn’t mean it lacks educational value.
Thinking about what the statement is expressing allows us to gain insight into the mindset of individuals.
It is recognition of the fact that when markets go up and down, many investors struggle to separate their emotions from their investments.
It ultimately tells us that for many an investor, regardless of whether markets are reaching new highs or declining, changes in market prices can be a source of anxiety.
During these periods, it may not feel like a good time to invest.
Only with the benefit of hindsight do we feel as if we know whether any time period was a good one to be invested. Unfortunately, while the past may be prologue, the future will forever remain uncertain.
Why it's important to stay in your seat as an investor...
In an interview, David Booth of Dimensional Fund Advisors was asked, what it means to be a long-term investor:
He said, “People often ask the question, ‘How long do I have to wait for an investment strategy to pay off? How long do I have to wait so I’m confident that shares will have a higher return than money market funds, or have a positive return?’ And his answer is it’s at least one year longer than you’re willing to give. There is no magic number. Risk is always there.”
It also helps to remember that, during what feels like good times and bad, one wouldn’t expect to earn a higher return without taking on some form of risk.
While a decline in markets may not feel good, having a portfolio you are comfortable with, understanding that uncertainty is part of investing, and sticking to a plan that is agreed upon in advance and reviewed on a regular basis can help keep investors from reacting emotionally.
This may ultimately lead to a better inves
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