"You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets."
– Peter Lynch
We all know that market corrections and bear markets are part of the investment landscape, and that it is inevitable that long-term investors will experience several of varying magnitude and duration in the course of their financial lives. However, knowing this and being able to accept it intellectually really doesn’t make it much easier to deal with emotionally when the markets start a steep slide. The first instinct is to cut your losses and sell, and it takes a great deal of discipline to keep your eye on your long-term investment goals and stick to your plan for achieving them.
It doesn’t help that the most severe of the twelve bear markets since 1946 is the one we all hold in recent memory: the financial crisis of 2008/2009 which lasted for 17 months. Plummeting 53.9% from its high in October 2007, the Dow experienced its largest drop since the 1930s. The S&P 500 fell below 700 in March 2009. Reaction from the media fuelled the panic as investors bailed from the markets. It is not surprising that now any precipitous drop in the markets triggers our recent fearful memories.
However, it is helpful to focus on what happened after the crash. By December 2014, the S&P 500 was up 212% after 68 months of a bull market.
In fact, stock market declines are normal and occur frequently. When an index like the S&P 500 falls 10% or more from a recent high, it is called a correction: there have been 19 corrections on the S&P 500 since 1946. Bear markets are declines of 20% or more from a previous peak. Historically (since 1946), the average duration has been 17 months with an average decline of 34%. However, the subsequent recovery has been very robust: on average, a 145% increase during a bull market lasting about five years. (You will often hear the terms ‘secular’ bull and bear markets, which refers to long-term alternations between up and down trends.)
After each correction of 10% or more on the S&P 500 during the period January 1926 – June 2015, the average annualized compound return for the first year following the correction was 23.56%. The annualized compound return over that entire period of time has been 9.32%. The important lesson here is that no one can predict when a downmarket will start or when it will recover: reversals happen suddenly and apparently without warning. We have shown in earlier columns the devastating effects on your portfolio of missing just 10 of the best days during a market recovery.
As we have often recommended in this space, the best approach is to construct a portfolio that anticipates that there will be market downturns and is designed to weather market volatility over the longer term. Of course, you should also make sure you have made liquidity provisions for unexpected expenditures so that you can stay invested during declines.
Trying to time the market to avoid short-term losses will likely have the unintended consequence of missing longer-term gains.
Dale Berg is a Senior Financial Advisor with Assante Financial Management Ltd. providing wealth management services to principals of family-owned and privately held companies. The information mentioned in this article is for general information only. Please contact him to discuss your particular circumstances prior to acting on the information above.