There is no doubt that the stock market is volatile. The questions are how volatile it could be, what differences are between short-term and long-term, and what we can learn from it.
Firstly, let's look at how volatile the stock market has been.
Figure 1 shows that the average intra-year decline of S&P 500 index was approximately 14.1% for the period from 1980 to 2016. The intra-year decline means the largest market drops from a peak to a trough during a year. In 2008, the intra-year decline was 49%. In other words, if you invested in an S&P 500 index fund through 2008, you would have experienced an approximately 49% decline in your account. It is quite volatile, isn't it?
However, what does the short-term volatility bring to the long-term investors? During the same period of 37 years, positive returns were seen in 28 years. And the average annual returns of S&P 500 was about 11.3% with dividends reinvested. How about the financial crisis? Assuming you were unlucky and put all your money in an S&P 500 index fund at the beginning of October 2007 right before the market crash, if you didn't sell after seeing your account declining over 50%, you should have already recovered from the loss and even doubled your money in 10 years as of December 1, 2017. To be more accurate, from October 2007 to November 2017, total S&P 500 return was about 107.7% and an annualized return was 7.5% with dividends reinvested.
Now, let’s compare the short-term volatility to the long-term volatility on a rolling return basis. This aligns more with investors’ actual investment experience and time horizon.
The findings in Figure 2 are very interesting. Let’s focus on the green bar which is the S&P 500 index here. The range between the highest return and the lowest return of S&P 500 is getting smaller as the rolling term gets longer. For any given 20-year period from 1950 to 2016, 7% was the lowest annualized compound rate of return. It equaled to approximately 3.8 times cumulative total return. How many of you have even tripled your money in the last 20 years? However, past performance is no guarantee of future results.
Therefore, what can we learn from this? The stock market is very volatile, especially in the short term. The less time you have for investing, the less percentage of your money should be allocated to the stock market. I usually don’t recommend investing any money in the stock market if you need the money in 3 years or less. On the other hand, if you don’t need the money for another 10, 20 or even 30 years, the volatility may reward investors who remain disciplined with their investment approach in the long term. There are many different investment approaches. You need to find the one that makes the most sense to you and stick to it. You could learn more about our evidence based investment philosophy here.
Lastly, all the figures in this post are coming from the 4Q 2017 “Guide to the Markets®” created by J.P. Morgan Asset Management. I highly recommend it to people who are interested in economics, finance or investing. You could view and download the quarterly report for free here.