Financial Markets

What to Remember When Markets Fall

“Don’t do something, just stand there!”
-John Bogle

This happens often.

The average intra-year decline of the S&P 500 is 13.8% per year.  2017 was an exception with the largest top to bottom drop being only 3% [1].

There have been 152 declines greater than 10% in U.S. Large cap stocks between January 1926 – December 2015.  The future 1 year returns after a greater than 10% decline has averaged 11.95% [2].

Long-term, the market is your friend.

The U.S. stock market (using the CRSP 1 – 10 index) has had 68 positive return years and 23 negative return years from 1926 – 2016, which means markets have been positive about 75% of calendar years [2].

Dow points don’t matter, percentage points do.

The Dow had the largest point drop in history on February 5th, but it didn’t even crack the top 100 on a percentage basis. Wiping out 1,000 Dow points when the index is at 26,000 is one thing, but losing 28 points when the Dow was 259 was much more catastrophic (This occurred on Black Tuesday in 1929).

The financial media doesn’t care about you.

Financial media doesn’t spend time educating investors about the importance of savings and the science of investing because that’s not what sells.  What sells is the allure of finding the next great stock tip, or a bold prediction that you can brag to your buddies about.

Rumor has it that all of the previous market calls these media pundits have made are buried in the same vicinity of Jimmy Hoffa.

Time in the market, not timing the market.

Attempting to time market can be costly.  The S&P 500 index earned 9.81% total return from 1990 – 2017.  Missing the 15 best days over that period drops your return to 6.18%, and missing the 25 best days drop your return to 4.53% [2].

Research has also shown that the best and worst days are often clustered together.  Investment legend, Peter Lynch, once said “More money has been lost trying to time the market than at the point of a gun”.

The risk of messing up the plan can be a greater one than a market drop.

Assuming a 25 year investment horizon on a $100,000 initial investment, the difference in ending value between a 9.81% return and a 4.53% return is $734,933.49.

Mathematically speaking, missing a 10% gain by being out of the market is not better than experiencing a 10% decline by being in the market.

Has the market drop affected your long-term goals at all?

The first response to a market drop for some people is to worry.  The first response should be “Has this reduced my chances of achieving my goals?”.  Market movements can certainly impact your chances of success but if a 10% market drop derails your entire financial plan, maybe it was an unrealistic plan to begin with.

Volatility hurts, but can lead to opportunities.

Volatility can be a drag on returns.  I illustrate this point below, two portfolios can have the same average return but differ greatly in value because of volatility.  The key is to try and have a portfolio of assets that are not all highly correlated.  High quality fixed income has been one of the best diversifiers throughout history and has helped dampen volatility.

Rebalancing at a time like this can be helpful.  If your portfolio target is 60% in stocks and 40% in fixed income, a major market move could shift you to let’s say 57% in stocks and 43% in fixed income.  A consideration should be made to rebalance back to target and take 3% from fixed income to invest in your stock portfolio at depressed prices.

Initial Investment $100,000
Year 1 Return Year 2 Return Average Return Compound Return Value at End of Year 2
Portfolio 1 50.00% -50.00% 0.00% -13.40% $75,000
Portfolio 2 10.00% -10.00% 0.00% -0.50% $99,000

This is a hypothetical illustration and is not intended to reflect the actual performance of any particular security. Future performance cannot be guaranteed and investment yields will fluctuate with market conditions.

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Mark Meredith and not necessarily those of Raymond James.  CRSP Cap-Based Portfolio Index data are a monthly series based on portfolios that are rebalanced quarterly. The universe includes all common stocks listed on the NYSE, NYSE MKT, and NASDAQ National Market excluding Unit Investment Trusts, Closed-End Funds, REITs, Americus Trusts, foreign stocks and American Depositary Receipts. Eligible companies with primary listings on the NYSE are ranked into equally populated deciles.

[1] JP Morgan 2017 Guide to The Markets.
[2] Dimensional Fund Advisors Market Declines and Volatility.