5 Lessons to Remember During Stock Market VolatilityMary Brunson
Friday, October 26, 2018
"As long as you are invested appropriately for your goals, stay away from your investment portfolio."*
In light of the recent stock market volatility, IFC would like to take this opportunity to share an important perspective courtesy of Dimensional Fund Advisors, and to remind you of five simple, but important investing caveats that can help you weather the recent market turmoil.
- Stock market volatility and downturns are natural and expected. Enduring them can be frustrating in the moment, but staying the course is essential in order to reap the long-term rewards of the global markets.
- Downturns enable retirement plan investors to systematically buy shares at various prices along their path toward retirement, providing a valuable opportunity to dollar-cost-average.
- It would be very nice to foresee market downturns and upturns, and to arrange our investments accordingly. Unfortunately, no one can reliably predict what the markets will do.
- Investing in a low-cost, risk appropriate and diversified portfolio, and staying the course has served patient investors well.
- Keep calm and listen to Warren Buffett’s advice on how to manage market downturns: He recommends investors "re-watch their favorite Super Bowl commercials, get ice cream with their kids and say hi to a friend they haven't spoken with in a while."*
The following video and article come courtesy of Dimensional Fund Advisors in response to the recent market turmoil
Recent Market Volatility
What should you make of recent ups and downs in the stock market? Here’s helpful context on volatility and expected returns.
After a period of relative calm in the markets, in recent days the increase in volatility in the stock market has resulted in renewed anxiety for many investors. From September 30–October 10, the US market (as measured by the Russell 3000 Index) fell 4.8%, resulting in many investors wondering what the future holds and if they should make changes to their portfolios.1 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 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 33 years out of the 39 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.
Exhibit 1: US Market Intra-year Gains and Declines vs. Calendar Year Returns
Reacting Impacts Performance
If one were to try and 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 in 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.
Exhibit 2: Performance of the S&P 500 Index
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-thoughtout 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.
1. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes.
Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.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 informational 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.