How To Embrace Stock Market Volatility (Hedgehog Portfolio Update)
Hey friends, Kelvin here.
We’re coming to the second half of this year in a few weeks’ time!
For the past few months, my team and I were working on revamping our Growth Investing Mastery course and launching our second course.* I’m very proud of our team and the members we serve.
(*Pssst – follow me on Instagram/Facebook to be alerted of early bird deals once it’s launched!)
By the way, before you go on and read anything on my blog, remember to check out my disclaimer page because my content is not professional advice nor is it a form of recommendation to transact in any securities.
It’s time for me to provide an update on the Hedgehog Portfolio.
Back on 17 February, I shared that the Hedgehog Portfolio hit $1.1 million and it was up 50.13%. Since then, the performance has been extremely volatile and I’m up >25% year to date (YTD).
I know some of you will ask why I didn’t sell off at the top and buy back at the dip.
Well, I am human too. Nobody knows what would happen.
It could equally have been possible that my portfolio would not drop and continued to rally. I would be missing out on much more then.
From my past experience, I know that when I have a portfolio of high-quality companies, the best thing is to do nothing.
The source of my returns do not come from timing the market. Rather, it comes from the earnings performance of my companies.
For the past few weeks, the stock market had been incredibly volatile. We witnessed fears created by rising treasury yields. And now, many also fear the potential interest rate hikes created from rising inflation.
From my perspective as someone who has been investing for nearly a decade, I would like to share how you can think of the stock market volatility.
Another big disclaimer here: I am assuming you are holding on to a portfolio of high-quality companies.
If you are holding on to lousy companies and the share price continues to drop, that’s not volatility and you should not add during the descend of its share price.
With that said, here we go!
1. Know That Stock Market Volatility Is Normal
Wanting to enjoy the upsides of the stock market without suffering any declines is like wanting to drive without encountering any red traffic lights.
Just think of it this way – even Warren Buffett can’t avoid red traffic lights!
You need to be God to do it. Just like the hot sun or rain, it is part of life and you cannot escape it.
While it is emotionally difficult to see your portfolio bounce around, it is during these moments of volatility where you will start to recognise the importance of having conviction in your companies.
Simply put, if you are afraid of volatility, it goes to show you still do not have enough conviction in your portfolio.
The market is irrational most of the time, but you do not have to be irrational.
Let me share an example to illustrate this.
Just for the past one month, this was the volatility of Sea Limited (NYSE:SE)’s share price:
It fell from $256.83 (29 April 2021) to $202.34 (13 May 2021) which represented a drop of 21%. This drop happened in almost 2 weeks’ time! Then, in 7 days’ time, it bounced back to $246.15 (20 May 2021).
Does it make sense at all? Did Sea lost 20% of their customers in two weeks then gained 20% of their customers back in one week?
The answer is clearly no.
Then why is it so volatile?
It is simply because of market sentiments, or as we call it, Mr. Market.
Mr. Market is psychotic. Some days, he is happy. Some days, he is depressed. It is very normal, and the best course of action is to accept his volatility.
After years of investing, I realised that focusing on the company is many times more productive than trying to guess how Mr. Market would feel for the month.
During moments of volatility, conviction gives you the courage to hold on to your shares while the fear from speculation tempts you to sell your shares away.
In 2018, Jeff Bezos told his team members, “when the stock is 30% in a month, don’t feel 30% smarter — because when the stock is down 30% in a month, it’s not going to feel so good to feel 30% dumber.”
This is why we should separate the company away from the stock. The stock is not the company and the company is not the stock.
Despite improving fundamentals such as a growing list of customers and increase in profits, the stock price may continue to fall because of market sentiments before recovering back up.
As an investor, you cannot escape volatility and your conviction will be tested on many occasions.
If you know your companies well, ignore volatility and stay vested with your good companies.
I’ll end with this quote from Peter Lynch, “know what you own and know why you own it.”
2. Stock Market Volatility Is a GIFT
Before I go on to my second point, I want to highlight that I often hear investors proclaiming that a volatile stock means the company is risky.
Let’s break that belief.
Even a company with record-breaking revenues and profits at every quarter could still have a volatile share price. Don’t let those false beliefs prevent you from buying into amazing companies.
If there are no changes in the fundamentals of a company, a stock is volatile simply because the market is volatile.
Sometimes, research analysts of reputable research houses such as Goldman Sachs and JP Morgan issue a valuation report on a company. That could easily affect their share price in the short term as well.
Remember, take research reports from analysts with a pinch of salt because some of them could simply be opinions.
Now, I want to frame to you why volatility should not be feared, but embraced as a gift instead.
Using Microsoft PowerPoint, I created a fictitious chart of company A and company B. Both companies started with their share prices at $20 in the year 2015 and both ended at $51 in the year 2021.
The difference is, company A is more volatile in nature.
Assume you have capital waiting to be deployed, which company is a better stock? Would it be company A or company B?
If you answered company A, you are right!
As an astute investor, we should let volatility work in our favour.
What do I mean by that?
Look, for company A, there were moments where its share price fell (marked by the red circles). For you who understand your company, these moments become an opportunity for you to accumulate more shares.
By the end of 2020, an investor who added more shares in Company A during the dips would end up with higher profits than an investor who invested in Company B.
This is why I find it so rewarding to understand my companies in-depth. It helps you to sail through the volatility, reap its benefits and sleep well even through corrections.
I will admit that changing your mindset about volatility is not easy, and it will likely take some time for you to get used to it.
However, once you are able to implement the concept, you will start seeing higher returns for your portfolio.
That’s one of my strategies to produce higher than average returns (+271%) during the year of the covid-19 pandemic (2020).
Embrace volatility because it helps you to achieve higher portfolio returns in the long run.
3. The Stock Market Will Go Up In the Long Term
Here’s a real example that most of us are familiar with: The S&P 500.
What is S&P 500? It is an index of the top 500 countries listed in American stock exchanges, which is representative of the U.S stock market.
Over time, the index committee makes decisions whether to add or delete companies from the S&P 500 index. Due to this regular review, weak companies are booted out while strong companies continue to stay on.
As strong companies continue to report higher profits and weak companies are removed, this is the reason why the long term trend of S&P 500 has always been in an upwards direction.
According to Moneychimp, if you held on to S&P500 from Jan 1971 to Dec 2020, your average returns would be 10.88%.
This was achieved despite all of the volatility created by the financial crisis, European debt crisis, Iran war, dot com bubble and covid-19.
When you zoom yourself out to see the bigger picture, you will realise that volatility is nothing but small blips, similar to speed bumps on the road.
Knowing this, what can you do today?
If you are not an investor who wants to spend time analysing companies, you can explore doing dollar cost averaging into SPY which is a mirror of the S&P 500 index.
But if you would like to achieve higher than 9 – 11% returns per year, you need to know the basics of understanding what makes a good company.
You can read books, find a good investor to mentor you, or try to figure it out by yourself.
(By the way, I provide a free walkthrough to select companies under the resources section of my blog. Click here to find out more!)
But no matter what your approach is, the key is you have to be very long term and you cannot give in to your fears during periods of volatility.
Closing Takeaways
- The stock market is psychotic and irrational most of the time. We need to know the stock is not the company and the company is not the stock. In the short term, stock prices might not correlate to the fundamental performance of the company, but it will eventually self-correct with time.
- Understand that volatility happens every day, it will hurt investors who do not know their companies but it will assist investors who understand their companies.
- To generate higher returns, you need to know how to analyse companies and understand how to value companies. Otherwise, invest in SPY to generate 9 to 11% returns per year through dollar cost averaging with a long term mentality
As always, I believe investing should be kept as boring as possible.
As long as you know your game plan, give it time for returns to come in.
Just like how a seed would not grow into a plant overnight, we should not expect quick returns from our investments. The big money is not made in the buying or selling, but it is in the waiting.
With that, once you achieve higher returns, you will be able to be financially sufficient quicker and have more control over your time.
By then, I hope all of us will start contributing to our society through donations or contributing our knowledge to guide others.
All right, that’s all from me, thanks for reading! You guys are great. ☺
P.S. If you’re looking to gain more than 9-11% per year and would like to explore some faster options for higher returns, feel free to check out my webinar for more details here!
