Walking the Dog [Post 18]

Understanding stock market returns can be a confusing thing to navigate as news headlines often don’t align with how markets react and “financial experts” tend to have conflicting opinions. So, let’s compare broad market returns, such as the S&P 500, to something we can all understand. Envision walking a dog.

All kinds of unpredictable things happen when taking a dog on a walk as they can be excitable creatures. They might stray from the sidewalk to chase a squirrel, stop to mark their territory on a fire hydrant, or pull hard on their leash attempting to run into traffic. The dog’s path is unpredictable and catches the attention of many observers.

When thinking about the market, the concept of walking the dog can make understanding short and long term returns easier.

In the short run, anything can happen. Economic news, legal actions, war, COVID, or anything of the like can cause short term volatility and movement as unpredictable as a dog. This also tends to be what most people pay attention to, even if they probably shouldn't.

In the long run though, the market behaves more like the dog’s owner - walking at a (mostly) constant pace in a desired direction. The market tends to act similarly when you zoom out, trending steadily upward as companies earn profits.1

Now this isn’t to say everything always works out perfectly. There can be long stretches of time that do not follow average expectations, or the stock market of an entire region can become “uninvestable.” Just like walking a dog, investing in the stock market carries risks and requires patience and discipline.

It can be difficult to do but looking past the sporadic behavior of the dog and buying into the long-term vision of the owner can be a good way to keep a level head when investing and avoid costly short sighted mistakes.

Ralph Wanger, a portfolio manager, is known for using the walking the dog analogy.

1. For example, view the all-time returns for the MSCI World Index.