Building Wealth Has No Shortcuts. Successful Investing Requires a Solid Investment Approach.
In recent days, the increase in volatility in the stock market has resulted in renewed anxiety for many investors. The world is watching with concern the spread of the new coronavirus. The uncertainty is being felt around the globe, and it is unsettling on a human level as well as from the perspective of how markets respond.
While it may be difficult to remain calm during a substantial market decline, it is important to remember that volatility is a normal part of investing. Additionally, for long-term investors, reacting emotionally to volatile markets may be more detrimental to portfolio performance than the drawdown itself.
Exhibit 1 below 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 observed had declines of more than 10%, and around a third had declines of more than 15%. Despite substantial intra-year drops, calendar year returns were positive in 34 years out of the 41 examined. This goes to show just how common market declines are and how difficult it is to say whether a large intra-year decline will result in negative returns over the entire year.
US Market Intra-year Gains and Declines vs. Calendar Year Returns
In US dollars. Data is calculated off rounded daily returns. US Market is measured by the Russell 3000 Index. Largest Intra-Year Gain refers to the largest market increase from trough to peak during the year. Largest Intra-Year Decline refers to the largest market decrease from peak to trough during the year. 2020 is year-to-date as of February 28, 2020. Frank Russell Company is the source and owner of the trademarks, services marks, and copyrights related to Russell indexes.
Reacting Affects Performance
If one were to try to time the market in order to avoid the potential losses associated with periods of increased volatility, would this help or hinder long-term performance? If current market prices aggregate the information and expectations of market participants, stock mispricing cannot be systematically exploited through market timing. In other words, it is unlikely that investors can successfully time the market, and if they do manage it, it may be a result of luck rather than skill. Further complicating the prospect of market timing being additive to portfolio performance is the fact that a substantial proportion of the total return of stocks over long periods comes from just a handful of days. Since investors are unlikely to be able to identify in advance which days will have strong returns and which will not, the prudent course is likely to remain invested during periods of volatility rather than jump into and out of stocks. Otherwise, an investor runs the risk of being on the sidelines on days when returns happen to be strongly positive.
Exhibit 2 helps illustrate this point. It shows the annualized compound return of the S&P 500 Index going back to 1990 and illustrates 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 being on the sidelines for only a few of the best single days in the market would have resulted in substantially lower returns than the total period had to offer.
Performance of the S&P 500 Index
In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero. S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. One-Month US T-Bills is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct.
While market volatility can be nerve-racking for investors, reacting emotionally and changing long-term investment strategies in response to short-term declines could prove more harmful than helpful. By adhering to a well thought out investment plan, ideally agreed upon in advance of periods of volatility, investors may be better able to remain calm during periods of short-term uncertainty.
Cogent Advice When Talking about Market Volatility
The evidence is piling up on why staying the course is your best course in volatile markets. News anchors, financial talking heads, friends, neighbors, acquaintances all have their opinions and their fears. If you don’t have a strong investment philosophy to ground you, it’s too easy to be knocked off-course. Every time you hear some new news or opinion about what to make of the most recent coronavirus news, it leaves you wondering anew what to do next.
We’d like you to think that one of the most important reasons you hire a financial advisor is to help you avoid just these sorts of market-timing perils – during just these sorts of tempting times. Showing you how to stick with a well-crafted plan based on your goals offers you your best odds in an uncertain world.
Life is uncertain. The market is even more precarious. This means building wealth has no shortcuts. Success requires a solid investment approach, a long-term perspective, and discipline to stay the course. Instead of leaving your financial future to chance, you need to have a plan. Cogent Strategic Wealth is here for you.
So, instead of worrying about your future, why not take positive steps to protect it? Set up a Cogent Conversation with us today. We’ll show you how to transform your hard work into durable wealth even through troubling markets.
Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss.
There is no guarantee investment strategies will be successful. Investing involves risks including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.
All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.
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