Markets Must Always Crash

No, we don’t forecast any imminent drop in the markets.  We just saw a good article on The Motley Fool that discuss why corrections happen and provide some good insights on what we preach on a regular basis.

“Decades ago, economist Hyman Minsky wrote about a paradox.  Stability is destabilizing, he said.  If stocks never crashed, we’d all think they were safe.  If we all thought they were safe, we’d rationally bid up prices and make them expensive.  When stocks are expensive, the inevitable whiff of danger, uncertainty, or randomness sends them crashing. So, a lack of crashes plants the seeds for a new crash.”

“The reason stocks offer great long-term returns is because they are volatile in the short run.  That’s the price you have to pay to earn higher returns than non-volatile assets, like bank CDs.  Wharton professor Jeremy Siegel once said, “volatility scares enough people out of the market to generate superior returns for those who stay in.”  Those are inspirational words for investors who assume they are brave enough to stay in; but not everyone can.  The volatility that sets the stage for superior returns is just a reflection of someone getting scared out of the market in real time.”

“Put this together, and you get an unfortunate truth that stocks offer superior returns for some because they offer a miserable experience for others. Without the misery, markets wouldn’t offer big returns, and without the prospect of big returns, markets will crash and cause misery. That’s why some investors must fail.”

Our last newsletter had a piece “The Risk Game” that we discussed how to approach your level of risk.  We would encourage you to read this again as it provides the solution in our opinion on how not to fail.  Goals need to be the main driver behind the level of risk you should accept.

Moral of the story…. Understand your tolerance for risks and don’t design your portfolio to set you up for failure.