Riding on a roller coaster requires you to have a strong stomach to tolerate the twists and turns. Sometimes, people will leave the roller coaster feeling nauseous because they couldn’t handle the intensity. Other times, people will feel invigorated by it. Funny enough, roller coasters are a great analogy for what investors deal with on a daily, monthly, and annual basis.
Many investors attribute success in the markets to stock-picking, and that successful stock-picking comes from having the knowledge of when to buy and sell a certain security. However, Peter Lynch, the famous mutual fund investor, would disagree. “In the stock market, the most important organ is the stomach. It's not the brain."
What does Lynch mean? Well, to start investing wisely, it’s best to know your pain tolerance for volatility in the markets.
To avoid getting nauseous, it’s best to choose the rollercoaster that you can handle instead of choosing one that’s too intense for your liking. Similar to investing, it’s best to choose the correct asset and stock allocation that you can handle to stay invested instead of making the classic, fear-driven mistake of selling low. For example, if Nick can’t tolerate the intense ebbs and flows of the stock market, it’s probably best for him to lower his stock allocation and increase his bond allocation to have a less volatile portfolio.
Having a better understanding of pain tolerance will allow an investor to weather through the worst conditions and be prudent in the best conditions in the markets. Ultimately, the biggest advantage an investor can have is staying invested, since the S&P 500 has averaged a 10% return per year while long-term government bonds have returned 5%-6% annually.
So, although contrary to popular belief, having a strong stomach to stay invested in the rollercoaster of the markets is a far better tool than having a brain that can pick the best stocks.
Sources: