Investing offers what in theory seems like an easy trade: long-term wealth creation for short-term volatility. But the reality is that it’s not so simple. The promise of gains over 10 or 20 years becomes less compelling as you face large market drops that take place over the course of a day or two, never mind when the losses accumulate for weeks or months at a time.
Make no mistake about it: investing is hard, and the most difficult part is managing your emotions against the swings of the market and the constant chatter from the financial media.
Below you’ll find two charts, courtesy of JP Morgan’s Guide to the Markets, that may make investing a bit easier.
The above chart shows calendar year returns going back to 1980. The gray bars represent the return for the year while the red dot shows the intra-year drawdown. What’s important to notice is that over the last 39 years, the average intra-year drawdown was nearly 14%. Fourteen percent! Do you realize that means? During that time period there was nearly one bear market per year. Yet, even with that kind of volatility, the stock market was up in 29 of those years, roughly 75% of the time.
The chart below shows the performance of an all stock (S&P 500) portfolio (green), all bond portfolio (blue) and a 50/50 split (gray), over different holding periods going back to 1950. From left to right, notice how the range of returns goes from extremely unpredictable to relatively predictable the longer you hold your investment. Even bonds can experience tremendous volatility over a one-year or even five-year time period. But, over longer time periods, the returns become more stable.
There are a few lessons you can take from these charts.
First, understand what you’re getting yourself into as an investor. Volatility, i.e., large swings in the price of stocks and bonds, are the norm; they are to be expected. When they occur, don’t think of them as outliers, think of them as the normal fits and starts of a healthy-yet-at-times-dysfunctional marketplace.
Second, no one knows what will happen over the next twelve months. My goodness, look at the range of potential outcomes! From the latter chart, a 50% stock, 50% bond portfolio has been anywhere from up 33% to down 15% in one year. There’s a tendency in all of us to want to know how the next year will look but the data show that it’s impossible to predict.
Third, and finally, it’s vital to understand your time horizon. That is, when do you plan on using your money? Any money earmarked for a goal five years or less into the future should be in cash. No ifs, ands, or buts. There’s too much uncertainty. Closer to retirement? Hold more in bonds. Early in your career? A heavier weighting to stocks is warranted.
Despite the positive returns on stocks and bonds so far this year, the past few weeks have been challenging for investors. The trade war with China, in addition to their currency manipulation, an inverted yield curve, plus the recent news that Europe’s largest economy, Germany, may be entering a recession, has investors worried.
As best you can, takes your eyes off the day-to-day. Don’t listen to the financial media. Remember: drawdowns are normal and volatility comes with the territory.
Focus on the long-term. The trade the stock market offers isn’t always an easy one, but the prize at the end is worth it.