Markets have experienced volatility in recent weeks, but price movements don’t mean that it’s time to abandon ship. Prices move as investors incorporate information, good or bad, and reflect their expectations about the future in their trades. Uncertainty also has an impact on prices. But while we tend to avoid the unknown, uncertainty is a persistent characteristic of investing. For an investor to earn above the “risk-free rate” they must weigh the tradeoff of taking on some level of risk. During new market highs or declines, it can feel like a bad time to invest. But a strategy you can stick with based on your goals and tolerances can help tame this anxiety. By understanding that uncertainty is an unavoidable component of investing, you can avoid reacting emotionally.
When the stock market is down for days or months, it is natural to question how long it will continue. But while turbulence may be frightening, it shouldn’t be unexpected. From 2001-2020, intra-year declines of the US Market ranged from 3% to 49%. While the declines were certainly scary, 16 of those 20 calendar years had positive returns.1
What comes up doesn’t necessarily come down when you’d predict. Market highs don’t ensure that stocks are overvalued or due for a correction. Rather, from 1926-2021, the average returns of the S&P 500 Index one, three, and five years after a new month-end market high were similar to the average returns over any one-, three-, or five-year period. (Why a Stock Peak Isn't A Cliff)
When emotions creep into investing, there can be a strong urge to get out before an anticipated decline. But research offers little evidence that these types of predictions are consistently successful. Even if you were lucky on the way out, you must also be able to precisely time when to get back in. Being out of the market during that time can lead to increased anxiety and decreased wealth. Moving away from equities to cash lowers expected returns. If someone is unable to perfectly time being out of the market, holding only cash can eat away at purchasing power due to inflation. While the stock market’s returns are impossible to predict, history supports an expectation of positive returns in the long-term.
Missing just a few of the market’s best days can have a devastating impact on a portfolio. $1000 invested in the S&P 500 Index in 1990 would have hypothetically grown to $20,451 through 2020. Omitting the S&P 500’s five best days and the return diminishes to $12,917. Miss the 25 best days and it grew to less than $5,000.2 (The Cost of Trying to Time the Market)
The not-so-distant past offers a compelling example of the rewards of staying the course. In 2020 with the uncertainty of the global pandemic looming, the US market sharply declined by 35%. While the anxiety at the time cannot be overstated, investors who remained invested were rewarded as the US market ended the year with 21% gains.2
Fed predictions, crypto movements, and the GDP have made headlines recently. Though you might hear some calling for a correction, you may have a smoother investment experience by tuning out the noise. The market is forward looking, and investors may have already priced in this information. Also, a major event in one market may not have the same impact across markets, which is a reason to diversify globally.
You likely don’t have power over what the Fed will do, what headlines are saying, or what returns will do in the short-term. But don’t let that get you down. Focus on what you can control: diversification, asset allocation, and tax efficiency.
This is why you have a plan. A trusted advisor can provide a dependable investment philosophy and develop a plan based on unique objectives and risk tolerances. Prudent financial plans, proper diversification, and discipline can help investors endure market movements.
Past performance is no guarantee of future results. Indices are not available for direct investment. Returns are in US dollars.
Dimensional Fund Advisors
1 Data is calculated off rounded daily returns. US Market is represented by the Russell 3000 Index. Largest Intra-Year Decline refers to the largest market decrease from peak to trough during the year. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes.
2 Indexes are not available for direct investment. Based on the total return of the S&P 500 Index from January 1, 1990, to December 31, 2020.