Improving Investor Behavior: The seen and unseen aspects of volatility

A few weeks back, a colleague showed me an article on commercial real estate in the Denver Tech Center. Apparently a few well-regarded buildings had changed hands at prices that caught his eye. One had originally been developed for $125 per square foot in 1996, only to be sold for $185 per square foot in 1998 — delivering the owners a tidy 48% return in just two years.

The surprising news was the sell price earlier this year: roughly $66 per square foot, or a 76% decrease in value since 1998. Taken at face value, that property represented a terrible long-term investment over 30 years. Of course, there are other factors to consider such as rents, maintenance, utilities, etc. But I’m sure it didn’t feel great to have an asset decrease by more than 75%, especially in what was considered a “relatively safe” asset class.

This serves as a great reminder: Volatility is everywhere. From real estate investing to stocks and even bonds, volatility is the price investors pay to generate a return. The greatest mistake we can make is fearing and avoiding volatility instead of openly embracing it.

I know what you’re thinking: Doesn’t volatility mean more risk? Not necessarily. Volatility is not the same as risk, and it’s important to understand the difference. Akin to flying, volatility is the turbulence we accept as a necessary, albeit uncomfortable, part of getting where we need to go. Rarely does turbulence measurably affect an airplane’s ability to reach a destination, even if it might result in a few queasy passengers. Alternatively, choosing to take the bus on your vacation is akin to avoiding the risk of flying altogether. You’ll get there … but exceedingly slowly. And there’s no promise you won’t be involved in a vehicle accident along the way.

Metaphorically speaking, bonds are like that bus. Bonds have long been sold as the “safe” investment: invest, wait a while, get your money plus a little interest back. Seems simple enough. That is, until the company’s ability to repay their debt comes into question. Even if we go with the absolute “safest” option, U.S. Treasuries, we find volatility.

Two months ago, the 10-year bond rate was 4.6%. Today it is 3.6%. This “safe” investment has lost roughly 22% of its prospective return in just two months. This is against the backdrop of inflation which, although slowing, is still increasing year-over-year. For long-term growth of purchasing power, this “safe” option leaves much to be desired.

Regardless of the investment, volatility pervades. And that’s OK. All asset classes have fluctuation; it’s completely normal. The challenge comes in recognizing this and controlling your reaction.

Imagine this: What would it look like if the news reported daily fluctuations on the value of your home? Right there, alongside your favorite stocks, was 123 Somewhere Street, here in Denver: “Today the value dropped 2%. It’s been on a downtrend for a month now.” Imagine if you could then sell it instantly with the click of a button. Would you do it?

Of course not.

Stocks get a bad rap, because their volatility is so front and center. As we’ve said time and again, it’s normal for equity markets to temporarily decrease in value by 10% to 15% every 12 to 18 months. The “problem” with any stock is we are updated every market minute with its current price. Up, down, or sideways, you can see with crystal clear accuracy the price action of your favorite investments.

In this way, the liquidity — or ability to buy or sell quickly — seemingly works against our human nature. The deluge of information and ease with which we can act on it makes a poor choice all too tempting. This starkly contrasts to real estate, in which pricing information and the friction related to buying and selling often make transactions significantly slower.