Imagine it is early January 2013. Your investment advisor calls you on the phone one morning and says,
"I've done my research and like the long-term prospects of Company X and think you should purchase some shares. The growth opportunity and fundamentals look promising over the next five to ten years."
You trust your investment advisor. You've been working with him for quite some time and have made money from his advice. So, you politely ask him how much Company X is trading for.
"$455 a share," he answers.
You reply, "Wow, that is a high price! And it looks like the stock price has already doubled in the last three years. Are you sure we shouldn't wait for the stock price to go lower first? I thought we liked to sell high and buy low. It seems like this investment would be the exact opposite. Plus, we have a new President that I disagree with on many issues, and I'm worried about this potential government shutdown I'm reading about. Besides, how much further can a stock at that high price go anyway?"
Your advisor responds with his everyday advice of not trying to time the market and how this is a long-term investment, blah blah blah. You know the phrases they use with clients all the time.
However, you put your concerns aside and decide to follow his advice anyway and purchase $25,000 worth of Company X stock. Three months later, your shares dropped 25% from where you bought them, validating all of your previous concerns and even causing some new ones to emerge about the mental stability of your investment advisor. Furthermore, the investment newsletter you subscribe to tells you that you should immediately sell a stock after a 25% drop in price.
So, you call up your investment advisor and ask him if you should cut your losses and move on. He reminds you about your conversations about long-term investing and how short-term price volatility and stocks are simply a packaged deal. He recommends that you continue to hold or even add to your shares.
You reply with, "Add to my shares? Are you crazy? No, I won't do that. But I will take your advice and hold. But, when I return to even, I may decide to sell then."
Eleven months later, the shares of Company X finally appreciated back to your original purchase price (Damn, I should have bought more when it was down). The stock yielded an additional 8% positive gain in the final two months. After enduring paper losses nearly every month throughout the year, you were finally in the green. But unfortunately, you didn't stay in the green for very long. By February 2014, you were back below your purchase price as the overall stock market sold off.
You call back your investment advisor, "I knew I should have sold it when I got back to even. This stock has gone nowhere for an entire year. I even had a small gain for a brief period. We should have sold then. I'm concerned about the volatility and losing more money."
Your investment advisor takes a deep breath and says to you, "I'm going to share with you some advice I learned from listening to Peter Lynch and his principles of investing. Mr. Lynch is known as one of the best investors of our time and even doubled the performance of the S&P 500 when he ran the Fidelity Magellan fund from 1977 to 1990. He claims, 'The average movement of a stock on the New York Stock exchange this century has been 50% between its high and low.' So, it is normal for stock prices to move a lot, both up and down, during any given year. You should expect it. Peter wrote in his book Beating The Street, 'A successful stock picker has the same relationship with a drop in the market as a Minnesotan has with freezing weather. You know it's coming, and you're ready to ride it out.'"
Your advisor continues, "I agree with this investment philosophy. And despite what happened to Company X's stock price this year, I still believe in its long-term growth potential. Now, are you willing to commit to the investment and ride it out or not?"
This advice finally made sense to you. And you decided that you agree that Company X has a great business and that trying to time the market was not something you or anyone else you know has been very good at. You let your advisor know you will exercise more patience and discipline when times get challenging. And that you genuinely are a long-term investor and not a short-term trader.
And thankfully, you did. Soon after, Company X's stock price began to appreciate. The board of directors also announced a 7-1 stock split, and the stock price ended the year up over 40% with substantial increases in their earnings. Your patience really began to pay off. And even though the subsequent years had many short-term periods of high volatility and double-digit selloffs, you stayed patient. You continued to hold your shares, allowing time for your share price to increase even more. The stock price split 4-1 again in 2020, and you now own 28 shares for every share you originally purchased back in 2013. Ten years later, your $25,000 investment had returned 10X your original investment.
You realize today that investing is not easy but worth it. Peter Lynch also says, "In the stock market, the most important organ is the stomach. It's not the brain." This means you must have the grit to stick with a good company during difficult times. He claims, "Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves." It is a valuable lesson to learn.
Can you guess who Company X is? Click Here for the Answer.
Notice each Calendar year the stock’s opening price and the difference between its high and low. Volatility is a packaged deal. Even with great stocks.
Good Investing,
Gregg Pacitti CFP®
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