Know how to react in the face of market volatility
It’s been a while since we as investors have faced sharp downward movements in the stock markets. But that’s exactly what we experienced during the first quarter of 2018. And most experts agree the volatility will continue for much of this year. Note volatility does not mean “down all the time,” as many investors seem to think. It means swings in both directions, so it becomes even more important that investors remain calm and don’t make any rash, short-term moves in an attempt to avoid losses.
Declines are certainly nothing new, but they seem especially surprising on the heels of an unusually calm 2017. From a recent article by Capital Group: “Even after sharp declines, market turnarounds can happen quicker than one might think. Intra-year declines in the S&P 500 have averaged 14 percent since 1976, but index returns were positive in 31 of those 41 annual periods.” In other words, most years end with positive gains despite relatively large, short-term declines during the year.
In fact, many investors hurt themselves when they attempt to time the markets. I have often heard clients say something such as: “I will get out of the market now, and then get back in when things look better.” That’s the very definition of market timing, and this type of activity should be avoided. “When things look better” often means the market has already rebounded, and that recovery growth has been missed. If an investor sells (or “gets out”) when the markets are at a low point, and then re-invests (or “gets back in”) when the markets reach a higher level, he or she has lost the opportunity to experience that increase from the low point. And, the market may even go down again after the initial recovery, creating a difficult cycle with little or no growth for the reactionary investor.
There are many good examples of why it’s best to stay the course and focus on the long-term results, but one excellent example is from JP Morgan utilizing data from Bloomberg. Over the past 20 years, the US stock market (as measured by the S&P 500 Index) had an annual average return of about 7.2 percent. If an investor were spooked by short-term declines and got out of the market for just the 10 best performing days of that 20-year period, he or she would have had only a 3.53 percent average annual return. If the 20 best performing days were missed, the average annual return drops to just 1.15 percent. The reality is that no one can accurately predict exactly when the “best” days and the “worst” days will occur. So, it’s best to avoid what essentially becomes a guessing game and stick to your agenda.
In yet another example, as mentioned above, since 1998, the S&P 500 has averaged about 7.2 percent per year, but the average investor has only averaged 2.6 percent per year over the same period. The “average investor” number is based on analysis by Dalbar, which uses the net aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Basically, investors can’t stay out of their own way, and the knee-jerk reactions negatively impact returns.
Human nature is a tough thing to overcome in any aspect of life. If we see the value of our money go down in a particular investment, it’s a natural reaction to want to get our money out of that investment as soon as possible. A prudent saver resists that urge and should be rewarded in the long run. It’s best to create a plan that fits your particular situation. Then, keep calm and stick to that plan, even though there will be times when your patience will be tested!