Did you fasten your seatbelt?
After such a year of fabulous returns and relative calm, the first quarter and the first few days of the second quarter have seen a return of volatility. This morning, my Wall Street Journal alert told me that Dow Futures were down over 500 points and poised to plunge at the opening bell. They did, but recovered nicely, up almost 1% by market close.
Does the recent market volatility cause a lot of anxiety for you? Markets are cyclical and prone to periodic corrections. It’s a normal part of the cycle and expected. Though we don’t welcome poor returns, we know that averages get to be averages for a reason and when we do planning, we build that volatility into your plan.
Trying to time the market means you must be right twice – knowing when to sell AND when to buy. Remember how many people assumed the market would fall after Trump was elected?
REACTING IMPACTS PERFORMANCE. 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.
The Exhibit below 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.
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-thought-out 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. The key is to have a plan.
In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero. S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. One-Month US T- Bills is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values. Credit - DFA