Optimism encourages a long-term prospective, it reduces emotional reactions, promotes discipline, helps you view challenges as temporary setbacks, and allows you to ride out periods of underperformance.
Caution ensures that investors set achievable goals and avoid taking excess risks, it helps temper exuberance and prepare investors for inevitable volatility. Consider;
“the average gain in an up year for the stock market since 1928 is +21%. The average loss in a down year in that same timeframe was -13%. Double-digit moves in both directions are the norm. In fact, in 70 of the past 97 years, the U.S. stock market has finished the year with double-digit gains (57x) or double-digit losses (13x).” 1
Last year turned out to be a relatively strong year for North American stock markets, which came off the back of a decent run in 2023. In fact, the S&P500 posted consecutive 25%+ years 1 providing pleasing returns to many client portfolios.
Balancing optimism and caution in investing is important because the stock market (historically) ends up with double-digit gains or losses in most years as referenced above.
While optimism allows investors to benefit from the market’s potential, caution helps temper expectations to prepare for the harder years.
This balance helps investors stay invested during volatile periods without overreacting to short-term losses or becoming overconfident during rising markets.
Given where we are today, we feel this is the most important aspect to discuss. Overconfidence in rising markets often leads to poor decision making. By staying cautious, we recognize that even in strong markets, unexpected risks can (and will) emerge. This story below by Howard Marks sums it up well;
“We hear a lot about “worst-case” projections, but they often turn out not to be negative enough. I tell my father’s story of the gambler who lost regularly. One day he heard about a race with only one horse in it, so he bet the rent money. Halfway around the track, the horse jumped over the fence and ran away. Invariably things can get worse than people expect. Maybe “worst-case” means “the worst we’ve seen in the past.” But that doesn’t mean things can’t be worse in the future. In 2007, many people’s worst-case assumptions were exceeded” 2
Balancing optimism and caution is a cornerstone of successful long-term investing. It allows us to embrace opportunities while staying prepared for unforeseen challenges. As markets continue to evolve, maintaining this balance helps investors navigate both the highs and the lows with confidence and discipline, ensuring they stay on track to achieve their financial goals.
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