As if the craziness we faced in September weren't enough, October is shaping up to be even nuttier. From the government shutdown to the looming debt ceiling, every passing brings more uncertainty to the market.
And if there is one thing the market despises, it is uncertainty.
A lesson on risk
The primary reason the market can't bear uncertainty is that any unanticipated shift in any moving part of the valuation equation can throw off the entire investment premise.
Every investment can be modeled as a series of cash flows either into the investment or back to the investor. The value of those cash flows is based primarily on how far in the future they're expected and how much risk there is of not meeting those expectations.
The less certain those cash flows, the higher the risk implied in them.
All else being equal, the higher the risk, the greater the return an investor will demand for taking on that risk. The way an investor gets that higher expected return is only by being willing to pay a lower price to buy the investment in the first place. As a result, the higher the anticipated risks on those future cash flows, the lower an investment's current price will be. When risk and uncertainty are building, prices can plummet quickly and fluctuate wildly.
In a nutshell, that means a sea of red ink is very possible, especially if breaching the debt ceiling puts in jeopardy the full faith and credit of the United States government to pay its debts.
To some extent, the global financial system is based on the premise that U.S. government debt is just about the closest thing to a "risk free" investment on the planet. "Every bond, an IOU of sorts from Uncle Sam, is backed by the "full faith and credit" of the United States government and, therefore, is considered by most investors to be the safest bet around.. A technical default on our debt -- even if only temporary -- could result in a worldwide shift upward in risk perception and downward in financial asset prices.
What can you do about it?
Ultimately, there's no way of knowing what will really happen if the U.S. defaults unless it actually does happen. But what is possible is to take a step back and ask whether any technical default will be a temporary glitch that gets quickly rectified or whether it will turn into the financial Armageddon that some predict.
There's a good chance that the entire debt-ceiling debate is nothing more than a high-stakes game of "chicken" and that there will be some compromise reached at some point. This far into it, there will be real consequences as a result of this game, no matter what form the final solution takes.
The key questions are what those consequences will be and how long they'll linger.
It could get ugly in the short term, especially if it takes a default to drive the compromise. But in the long run -- this, too, shall pass.
With that in mind, think back to the bubbles and financial crises of the past 14 or so years. Between the dot-com bubble, the housing bubble, and the Great Recession, it hasn't exactly been a walk in the park financially. Add a few wars, nuclear-plant meltdowns, city-leveling earthquakes, hurricanes, tsunamis, and acts of terrorism, and the world hasn't exactly been a stable and safe place, either.
Still, despite all that risk and uncertainty, it was very possible to make money investing over that time period, even if you started around January 2000 -- just before the dot-com bubble burst.
The following chart shows an estimate of what a person could have gotten from simply investing $500 every month in the market tracking S&P Depository Receipts (SPY) and reinvesting dividends along the way:
Chart calculated on data from Yahoo! Finance, as of Oct. 1, 2013.
Simply by putting $500 every month into that market-tracking index ETF, an investor would have built a portfolio worth around $135,000 over a bit less than 14 years. Not bad for the crazy times we've lived through in the interim.
While the debt ceiling does certainly pose a risk, history suggests that if it's of the type that we'll get through eventually, then the simple act of consistently investing is a great way to build wealth in the long run, no matter how choppy the short run.
And if, by some chance, the debt-ceiling debacle does turn into Financial Armageddon, well, there's an old saying: "Owe your banker 1,000 pounds and you are at his mercy; owe him 1 million pounds and the position is reversed." If I owe you $100 and I can't pay, I have a problem. If I owe you $17 trillion and I can't pay, you have the problem.
Don't let it be your problem
The key to building that $135,000 nest egg since early 2000 was consistently coming up with the $500 every month to invest. Without that critical foundation, rather than $135,000, you -- or any other investor -- would wind up with $0.
Don't let fear of the unknown or the uncertainty of the short term keep you from making the long-term investment plan that will set you up for success over the next several decades. Over time, no matter what the market does, you'll be better off following a decent investing plan than you will be if you don't invest at all.
It doesn't take a highly sophisticated strategy or a lightning-fast connection to the market data feeds to invest successfully. But it does take the ability to come up with the cash to invest and the discipline to keep at it for the long haul, no matter what the risks of the day may look like.
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