Squeeze The World

Expect a Down Market 25% of the Years - What Should an Investor Do?

Squeeze The World

It is difficult being a patient investor in a frantic and always available news environment. Everyday we are bombarded with “bad” news:  Will Greece default on their debt and exit the Euro? Is China’s economy going to slow down? There are even concerns about sales slowing for beloved Apple. And everyone has an opinion of how you should invest your hard-earned money in this current environment.

So what should an investor do?

Stay Focused on the Long-Term

Charles Ellis, a noted investment author stated, “The average long-term experience in investing is never surprising, but the short-term experience is always surprising.”

To illustrate what Mr. Ellis stated, let’s look at the short-term return distribution of the S&P 500 Index. The below chart illustrates the 1-year monthly rolling period returns for the past 50 years, 7 months. As you can see, there is a wide distribution of returns from the mean. You could be down 43% or up 61% … and every number in between. This is what we call uncertainty!

But now let’s look at 25-year rolling period returns for the S&P 500 over the same time period. The mean return is almost the same, but look how the distribution of returns has dramatically narrowed. Beautiful!

Risk and return are interrelated, there is no doubt about it, but you can help control your risk by following these three very important factors:

  • Invest in low-cost, globally diversified index funds;
  • Determine how much risk is right for you;
  • Stay the course through both up and down markets.

Expect and Plan For a Down Market

One of the many benefits of having historical market data is that we are able to use it to better understand and characterize both the risks and returns of asset classes and empower investors to make better decisions. With this long-term data, the chart below illustrates that every investor should expect a down market 25% of the time – about every 1 in 4 years.  Just expect it, don’t worry about it, and keep enjoying life.

Another point this market history shows us is that stock market declines are temporary, but the overall upward trend is permanent! The chart below shows the growth of a dollar over the last 87 years, marked with 15 major news events. While the news events created volatility, they were largely irrelevant in the long-term outcome. This chart also further supports the fact that quality data provides the most useful tool for investors to construct risk appropriate portfolios.

In summary, the use of long-term historical data enables investors to build an asset allocation that meets their own risk capacity and equips them with the knowledge to withstand short-term volatility. Investors should rely on large sets of historical data when building an investment portfolio.