From February 1–8, the US market (as measured by the Russell 3000 Index1) fell over 8%, resulting in many investors wondering what the future holds and if they should make changes to their portfolios. Financial news outlets were quick to jump on the commotion, as you’ll find headlines filled with “chaos,” “turmoil,” and “panic.” However, here are a few of the headlines2
“Another normal year in the market, as stock prices decline.”
“Recent decline offers little insight about the future.”
Exhibit 1 shows calendar year returns for the US stock market since 1979, as well as the largest intra-year declines that occurred during a given year. During this period, the average intra-year decline was about 14%. About half of the years had declines of more than 10%, and around a third had declines of more than 15%.
However, despite substantial intra-year drops, calendar year returns were positive in 32 years out of the 37 examined. As you can see, the recent decline is normal behavior for a functional auction market and tells us very little about the future.
“Market timing isn’t the answer.”
Market prices aggregate the information and expectations of all the thousands of market participants better than we can individually. Information that’s available and the opinions of investors everywhere are built into current prices. If that’s true, stock mispricing can’t be systematically exploited. Meaning, we can’t time market!
This point, supported by the fact that a substantial proportion of stock returns come from just a handful of days, leaves long-term investors with plenty of incentive to remain invested.
Exhibit 2 helps illustrate this point. It shows the annualized compound return of the S&P 500 Index going back to 1990 and shows the impact of missing out on just a few days of strong returns.
“Market timing isn’t the answer.”
“Investors wisely staying in the game.”
Market prices aggregate the information and expectations of all the thousands of market participants better than we can individually. Information that’s available and the opinions of investors everywhere are built into current prices. If that’s true, stock mispricing can’t be systematically exploited. Meaning, we can’t time market!
This point, supported by the fact that a substantial proportion of stock returns come from just a handful of days, leaves long-term investors with plenty of incentive to remain invested.
Exhibit 2 helps illustrate this point. It shows the annualized compound return of the S&P 500 Index going back to 1990 and shows the impact of missing out on just a few days of strong returns.
The bars represent the hypothetical growth of $1,000 over the period and show what happened if you missed the best single day during the period and what happened if you missed a handful of the best single days. The data shows that mistiming or being on the sidelines for the best single days substantially lowered returns for the entire period.
There wasn’t a whole lot of rejoicing the past few weeks, but should savers really fear these types of market declines? For those regularly contributing to their investments, the short-term volatility will actually aid their long-term returns. How? The assets they want to buy just went on sale! “Savers rejoice as stocks go on sale.”
Figure 3 shows the historical growth of US Large and Small cap stocks. Since 1926, there have been tremendous amounts of ups and downs. Some were quite serious (Great Depression, the 1973 crash, Dot-Com Bubble, Great Recession). We were reminded these last two weeks that stocks carry risk. Yet long-term results reward disciplined investors, even through all the short-term volatility. So rejoice, savers, and keep saving!
Conclusion
While market volatility can be nerve-racking, reacting emotionally and changing long-term investment strategies can prove harmful. With each new decline, try to look past the noise and remember the headlines that you don’t see.Video
For more insight, view this video about expected returns before, during and after market declines. Market highs and market declines offer little insight about future expected returns (for the long-term investor).
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2These, of course, aren’t actual headlines. Just
simple truths you won’t always see in the papers!
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