The strong equity returns of 2020 and 2021 seem a distant memory as investors contend with a bear market and stomach-churning market moves. Market volatility can wreak havoc on investor emotions, creating the temptation to trade in or out of the market based on the latest developments.
Investors should fight the impulse to time the market, as over the long term whether you invest is far more important than when you invest.
Although today’s bear market may feel worse than prior bear markets, there are important historical patterns that may be instructive today. Investors should also reconsider the most frequently used definition of risk, as market volatility may be the wrong definition of risk for many investors. With that in mind, here are three investing truths that could be helpful right now.
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Truth: Long-term market returns include periods of poor returns
Stocks rarely rise without experiencing setbacks along the way. Since 1980, calendar year returns for the S&P 500 Index were positive in 32 of the 42 years. However, during that 42-year period, the S&P 500 index had an average intra-year decline of 14%.
For investors saving for long-term goals, such as education and retirement, longer-term returns are more relevant than annual returns. Since 1970, the S&P 500 provided positive returns in 90% of five-year periods and 95% of 10-year periods.
Investors choosing to be in cash rather than invest in stocks should know that cash has historically been poor at preserving purchasing power, providing a negative real return after taxes and inflation. According to Goldman Sachs, from 1986 to 2021, cash earned a 3.5% total return, which became 0.8% net of inflation and -0.6% after inflation and taxes. Stocks provided superior returns than cash net of inflation and taxes.
Truth: ‘Prediction is very difficult, especially if it’s about the future’
The quote attributed to Niels Bohr, a Nobel laureate in physics and father of the atomic model, provides cautionary advice for investors who think they can successfully time the market. Morningstar’s annual study of 20-year returns provides evidence supporting Bohr’s (and baseball sage Yogi Berra’s) cautionary warning about the perils of trying to predict the future.
Investors in the U.S. equity market for the full 20-year period through the end of 2021 earned 9.5% per year, while investors who missed the 10 best days saw their returns drop to 5.3% per year. Investors who missed the 20 best days paid an even steeper price, with returns falling to 2.6% per year. Although avoiding the 10 worst days would boost returns, the best and worst days tend to be clustered together, making it nearly impossible to trade with the perfect foresight to capture the best days while avoiding the worst days.
Truth: Market volatility and risk are not the same thing
Many investors confuse volatility and risk. For most investors, short-term market volatility should not matter. Most investors have investment time horizons that should be measured in decades rather than days or months. Permanent loss of capital associated with making bad investments or selling at inopportune times is far more damaging than short-term market volatility.
Most causes of permanent loss of capital are self-inflicted. Failing to maintain enough liquidity to meet unexpected expenses increases the likelihood of having to sell assets at inopportune times. Being overly leveraged also raises the vulnerability of being a forced seller, the unfortunate fate of too many real estate investors in 2008 and 2009. Investors should revisit their investment time horizon and consider accepting more day-to-day portfolio volatility in exchange for higher longer-term return potential.
The bottom line
Investors should resist the understandable impulse to try to time the market. Volatility often creates investment opportunities, however, there is a profound difference between making incremental portfolio changes to take advantage of opportunities created by market volatility and “all-in/all-out” strategies to try to call market tops or bottoms.
Those who need to “do something” in response to volatile markets should recognize the fundamental difference between investing and speculating, and only speculate with a small percentage of their overall portfolio. Building wealth over time typically comes from patience and “time in the market” rather than frenetic trading in response to the latest headlines.
Disclaimer
Registration with the SEC should not be construed as an endorsement or an indicator of investment skill, acumen or experience. Investments in securities are not insured, protected or guaranteed and may result in loss of income and/or principal. Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable.
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