This post may seem a bit “out there,” but it’s something I’ve been thinking about recently, and I’d love to hear your thoughts. First, a few trends:
- According to the Investment Company Institute, the percentage of American households that own stocks (including shares held through mutual funds) has increased from 19% in 1983 to over 50% today.
- The transaction costs of buying or selling a share of stock have decreased dramatically over the last 10 years due to competition from online discount brokerage firms.
- Similarly, the promulgation of no-load funds has reduced the cost of buying and selling shares of funds (and thus shares of actual companies).
- The percentage of people handling their investments on their own (as opposed to via a broker) has also increased dramatically over the last decade due to online account access.
- The financial media (both online and offline) has spent enormous sums of money to convince people that it’s imperative to monitor (and react to) the daily motions of financial markets.
Think for a minute about how these trends might interact. We have:
- More and more people owning stocks,
- An entire industry built around convincing them that it’s beneficial to buy and sell at a rapid pace, based entirely upon short-term market events,
- Lower transactional costs, thereby leading to increases in rapid buying/selling, and
- A greater ability to make transactions without at least talking to another human being (who might happen to be somebody in the possession of some long-term perspective).
Is it possible that we’ve created a system in which there are more and more people following a herd instinct (whether the herd is buying or selling at the moment) with nothing to stand in their way?
Perhaps every major economic event will now have a greater impact (whether upward or downward) on the financial markets than it would have had two decades ago. Perhaps we’ve entered an era of permanently higher volatility in the stock market.
Of course, long-term market results will still roughly equal the sum of corporate dividend yields and earnings growth. But it seems entirely possible to me that we’re in for a bumpier ride from year to year than investors of previous generations.
Now don’t get me wrong, I see it as a very good thing that a higher portion of American households have an ownership stake in our economy than ever before.
I’m just wondering if there will be side effects.
What do you think? Are we in for an extended period of greater volatility going forward? Or will some other factor(s) cause an effect in the opposite direction, thereby negating such a trend?
New to Investing? See My Related Book:
 |
Investing Made Simple: Investing in Index Funds Explained in 100 Pages or Less  |
- Asset Allocation: Why it's so important, and how to determine your own,
- How to to pick winning mutual funds,
- Roth IRA vs. traditional IRA vs. 401(k),
- Click here to see the full list.
A Testimonial:
"A wonderful book that tells its readers, with simple logical explanations, our Boglehead Philosophy for successful investing." - Taylor Larimore, author of The Bogleheads' Guide to Investing
Really interesting post, Mike. I hadn’t thought about it before, but you make a good point. Of course, being 25 makes me think wishfully that you’re right! As we know, volatility can be our friend.
Indeed it can, provided that we have the time (and the stomach) to wait it out.
I think trends in volatility come in cycles. In the early 90′s and from 2002-2006, vol came down to historic levels, prompting people to proclaim we’re headed for a new era of low vol, guided by the effective monetary hand of the Fed. Similarly, I think the high level of vol we see now will eventually stabilize over time once investors start regaining their risk appetite.
Food for thought, Mike. I agree with Jay that volatility has always been a cyclical thing, although there’s no doubt last year was an extreme event, with as many big daily rises and falls as you’d normally get over several decades. (Don’t have the exact figures to hand).
You could probably also add programmed trades to your list of causes – hedge funds computers dumping and buying. This is now seen as the probable cause of the ’87 crash, and some of the selling of late last year looked like it was being done by robots.
Comments on this entry are closed.