Prior to Feb. 2, 2018, the stock market had been through a remarkably tranquil period. Since that date, the U.S. stock market has experienced multiple days with drops of 2 percent or more in a short period of time. Here, though, we will focus on the long-term investing concepts investors should keep in mind, as well as historical context for market moves of this magnitude.
Markets are notoriously difficult to forecast over any horizon, and this difficulty is only amplified over shorter periods of time. Nevertheless, this won’t stop some market “professionals” from trying. Investors would be wise to ignore these forecasts in their own decision-making. Yes, markets are currently extremely volatile, but that volatility might not continue, and no one can reliably know whether stocks will move up or down from here. In fact, no one can even clearly know what caused the drop over the last week. Some commentary we have seen points to inflationary concerns, while other pundits blame anxiety around the U.S. budgetary process. Still others believe the market is concerned the Federal Reserve may raise interest rates too quickly. Who’s to say which, if any, of those explanations are correct, much less what that implies going forward. What we do know, though, is that over the long term, investors can expect to be rewarded for investing in a low-cost, diversified portfolio of stock funds.
The recent past shows us just how wrong consensus, short-term forecasts can be. Two recent examples are the post-financial-crisis prediction of higher interest rates and the expectation that the stock market would decline following the 2016 presidential election. Both predictions were clearly wrong, and investors who acted on them instead of focusing on the long-run evidence that markets tend to reward risk-taking were harmed.
Your Plan Should Incorporate Risk
One of the advantages investors have today compared to investors in the early part of the 20th century is that we now have decades-worth of data to help us understand long-run returns and risks. For firms in the BAM ALLIANCE, we maintain an extensive database of the risk profiles associated with the portfolios that we recommend to clients. This data allows us to incorporate risk into the way we build clients’ financial plan, meaning that outcomes like the market falling by 2, 3 or 4 percent over a handful of days already are reflected in our recommendation. Our investment committee is well aware that these events — however unpredictable — will eventually happen, and advisors in the BAM ALLIANCE therefore imbed this knowledge in the comprehensive planning process that results in each client’s portfolio allocation.
Putting Market Risk in Historical Context
The following graph plots the historical annual return of the U.S. stock market in each year (in blue) from 1926 through 2017 and the largest intra-year decline (in light blue outline) that occurred in each of those years.
Annual Stock Market Returns and Intra-Year Declines
There are two primary takeaways from this graph. First, as we all know, the stock market goes up far more often than it goes down. Second, but possibly less well known, virtually every year includes a period of time where markets fell precipitously. It’s clear, though, that these intra-year declines don’t necessarily signal whether the market will be up or down over that particular year. But it does show that stock markets have and always will be risky, particularly over shorter periods of time.
Are There Any Actions to Take?
Given what we know, we obviously don’t recommend making drastic changes to a portfolio allocation as a result of short-term market moves already accounted for in the planning process. The portfolios BAM ALLIANCE firms create for clients are well-thought-through and built to be highly diversified. But are there any other actions worth considering? If you haven’t recently, now could be a good time to reassess your investment plan from a long-term point of view.
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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
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