- October 20, 2018
- Bob Quinn
After a period of relative calm in the markets, the increase in volatility in the stock market in recent days has resulted in renewed anxiety for many investors.
While it may be difficult to remain calm during a substantial market decline, it is important to remember that volatility is a normal part of investing. Additionally, for long-term investors, reacting emotionally to volatile markets may be more detrimental to portfolio performance long term.
The graph below shows calendar year returns for the US stock market since 1979, as well as the largest intra-year declines that occurred during a given year. The largest intra-year decline refers to the largest market decrease from peak to trough during the year. During this period, the average intra-year decline was about 14%. About half of the years observed had declines of more than 10%, and around a third had declines of more than 15%.
Despite substantial intra-year drops, calendar year returns were positive in 32 years out of the 37 examined. This goes to show just how common market declines are and how difficult it is to say whether a large intra-year decline will result in negative returns over the entire year.
The largest intra-year gain refers to the largest market increase from trough to peak during the year.
US Market Intra-Year Gains and Declines vs. Calendar Year Returns, 1979–2017
In US dollars. US Market is measured by the Russell 3000 Index. Largest Intra-Year Gain refers to the largest market increase from trough to peak during the year. Largest Intra-Year Decline refers to the largest market decrease from peak to trough during the year. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes.
Reacting hurts performance
It might be tempting to think that you can somehow time the market in order to avoid the potential losses associated with periods of increased volatility. If current market prices aggregate the information and expectations of market participants, stock mispricing cannot be systematically exploited through market timing.
In other words, it is unlikely that investors can successfully time the market, and if they do manage it, it may be a result of luck rather than skill. In any case, a substantial proportion of the total return of stocks over long periods comes from just a handful of days, which makes timing the market difficult to achieve – you are unlikely to be able to identify in advance which days will have strong returns and which will not.
“Everyone’s got a plan until they get punched in the mouth”
– Mike Tyson
Tune out the noise
So the prudent approach is to stick with it during periods of volatility rather than jump in and out of stocks. Most of us have busy lives which makes keeping a close eye on market movements impossible. You take your eye off the ball for a few days and you run the risk of being on the sidelines just when returns happen to be strongly positive. How frustrating would that be?
Yes, market volatility can be nerve-racking. However as the data suggests, changing long-term investment strategies in response to short-term declines rarely works in your favour. When you have a well-thought-out investment plan, ideally agreed upon in advance of periods of volatility, it is easier to remain calm during periods of short-term uncertainty.