The stock market has delivered a very volatile week to investors, perhaps striking a nerve not felt since 2008. As I write this, the S&P 500 has dropped more than 5% in a week and almost as much today, causing many investors to recall the sickening downturn of what some called “The Great Recession.”
Since 1980, the average intra-year decline for the S&P 500 has been -14.2%, even though annual returns were positive for 27 of those 35 years, or 77% of the time.
The S&P 500 has more than doubled in value from March of 2009 , and we have gone more than 1,400 calendar days without as much as a 10% correction. This is the third longest stretch in over 50 years without such a decline. Since 1928 the S&P 500 has experienced a 10% correction almost once per year with an average recovery of 8 months.
Corrections of 20% or more for the S&P 500 have historically occurred at the end of market cycles. In the short run the S&P 500 has pulled back 5% an average of four times per year, or about once per quarter. In fact, the S&P 500 has experienced a 5% or greater pullback every year since 1995. Drawdowns of 2%-3% occur far more often, at least monthly on average. As such, pullbacks alone should not be a reason for panic.
In times of increased volatility such as we have experienced, it’s important to revisit these important lessons that are the underpinning of a successful investment strategy.
- Markets are efficient. We may not like the market’s reaction to the news that has dragged it down in the last week, but the market is doing its job. Willing buyers and willing sellers go to the market to agree upon a price for each security. Each price reflects all known information. It is important to understand this one simple point because if you decided to buy or sell now based on what has happened—don’t bother, it’s already in the price.
- Market timing is speculation. Investors who take action based on what they think will happen next are merely gambling on a future outcome. Rather than relying on speculation, blind faith, or anecdotal evidence, our philosophy rests on a solid foundation of core principles from the science of investing.
- Diversification is the only antidote for uncertainty. Although diversification neither assures a profit nor guarantees against loss in a declining market, a properly constructed and well-diversified portfolio is a key component of a successful investment experience. We design portfolios that attempt to capture certain risks and eliminate others, depending on your preference and capacity for various types of risk.
- There is no free lunch (risk and return are related). Higher expected returns only come from bearing more risk that cannot be diversified away. Much like a football player who chooses to play without a helmet, you should not expect to be paid more for taking risks that can easily be avoided. We focus on eliminating risks you should not expect a reward for taking, like concentrating your portfolio in just a few stocks.
- Save yourself from yourself. Legendary investor Benjamin Graham tells us: “The investor’s chief problem – and even his worst enemy – is likely to be himself.” What you need is the temperament to control the urges that get other people into trouble in investing. In other words, realize the long-term expected return of your investment portfolio has not changed in the wake of the current volatility, so look away. Sounds too simple? Yes, it is simple advice, but it is not always easy to follow. The media will do nothing to assuage the panic or fear. In fact, they will beat the drum because it keeps people tuned in. Their advertisers pay for eyeballs on the screen, and they’ll do whatever it takes to get them and keep them there. Turn off the TV; step away from the computer; go for a walk. You’ll be glad you did.
- Remember the bad times. Sounds odd, doesn’t it? Who wants to recall the angst of 2008 and early 2009? It was painful. The important thing to remember is: Those who held on came through far better than those who panicked and fled the markets. Historically, the market has always carried a positive expected return. Investors would not risk capital without the expectation of a positive return. You don’t always get it, but it is there. You cannot obtain the positive expected outcome of the market unless you are in the market—buying, holding, bearing and rebalancing risk. We know the drill; we have suffered extreme volatility in the past, and we have endured. We invest in an approach that strives to capture a fair share of the capital market return based on the risk assumed.
- Remember your time horizon. The best time to be in the market is when you have the money and the best time to be out of the market is when you need the money. If you need the money right now, the stock market is not the right place for you. But, if you have a time horizon of four or more years, you can withstand some volatility to increase your risk-adjusted returns.
While what has happened in the markets recently has been unnerving, we believe in our strategy of broad global diversification. Your portfolio is appropriate based on your individual financial goals. In the long-term, big market drops are just noise and should have no major impact on your life plans. If your goals have not changed, there should be no need to adjust your asset allocation. This too shall pass.