Stocks have seen some wild price swings over the past couple of years; sometimes it feels more like a casino than a market. Emotions can play a big role in how stocks behave day to day, even though a company's growth and financials are what typically drive investment returns over the long term.
In fact, famous investor Peter Lynch once declared that the stomach, not the brain, is the most important organ for investing in the stock market. In other words, how an investor handles volatility can have a lot to do with how their portfolio performs. There is no free lunch on Wall Street; here is why you've got to embrace the ups and downs if you want to score big returns.
Today's blue chip stocks weren't smooth rides
Investors hold up companies like Amazon (AMZN 0.18%), Apple (AAPL -2.23%) and Tesla (TSLA -2.16%) as no-brainer winners that investors can buy with confidence. The tremendous wealth these stocks have created has a lot to do with that. Imagine one made hypothetical investments of $10,000 into each company's IPO. Over these stocks' lifetimes, those investments would be worth:
- Amazon: $13.0 million
- Apple: $15.9 million
- Tesla: $1.7 million
Investors anchor to the cumulative success of these stocks but often don't realize how stressful the journey was along the way. To enjoy the wealth that Amazon created for investors, one would have had to endure a more than 90% decline during the dot-com crash in the early 2000s. Shares fell so much that Jeff Bezos started his 2001 shareholder letter with the word ouch.
Apple is the largest winner of these three, but investors had to endure three declines of more than 75% and several others of at least 50% over the years. Remember, Apple wasn't Apple back in the early 2000s; investors likely felt their stomachs churn, seeing their investment repeatedly lose most of its value. But those who sold likely never saw the long-term rewards that followed the hard times.
Consider Tesla, one of the most controversial companies on Wall Street, having almost as many die-hard critics as shareholders. Tesla stock will fall 30% to 40% routinely; one wouldn't blame an investor for succumbing to the constant chatter and noise around the company. But that volatility was the price paid for the explosive returns over the past three years.
How to turn thousands into millions
Huge investment returns have a price; investors often must endure volatility's painful ups and downs. By the time Wall Street broadly agrees that a company is a blue chip stock, it's likely too late -- the life-changing returns have already been had. Buying Amazon today will probably prove an intelligent long-term decision, but investors shouldn't count on the same level of returns that turned $10,000 into millions.
The next Amazon, Apple, or Tesla is probably among the rubble today, stocks that the current bear market beat to depressingly low prices. There will probably be investors who realize down the road that they once owned the next big thing, and the market's volatility scared them into selling it.
How do you defend against this? Investors should have a diversified portfolio so that getting some stocks wrong doesn't sink your whole ship. Remember that a stock can only lose 100% of your investment, but the upside is thousands of percentage points. Getting one right can make up for getting a lot wrong.
Most importantly, focus on a company's fundamentals -- its growth, financial health, and overall business model. Jeff Bezos' 2001 shareholder letter started with ouch but proceeded to list all the things Amazon's business was doing right. If you do your homework, diversify, and endure the short-term stress of volatility, you'll put yourself in the best position possible to win on Wall Street.
