When, for a variety of reasons, the stock market experiences downside pressure, I often spend a lot less time on the headlines and more time on the history. Because every market presents itself differently with no up or down move in the market looking exactly like another, I am compelled to look at what the market has shown us through data that goes back to 1825.
After tearing up several drafts over the past few days, I pray I’ve struck the right tone in what you are now reading. There are several key points I’d like to share after a long weekend of research.
Stock market fluctuations are an inevitable part of investing. Declines in the market never feel good but are quite normal to experience. History has shown us that declines have varied widely in intensity, length and frequency.
A History of Declines from (1900-December 2014)
Dow Jones Industrial Average
Type of Decline Ave. Frequency Ave. Length
|-5% or more||3 times per year||46 days|
|-10% or more||1 time per year||115 days|
|-15% or more||1 time every two years||216 days|
|-20% or more||Approx. once every 3 1/2 yrs.||338 days|
As a different point of reference, when observing the market between the years 1825-2013, I see the following:
- The market had 134 positive years and 55 negative years (the market was positive 71% of the time)
- 44% of the time, the market finished the year between 0% and +20%
- 60% of the time the market finished the year between -10% and +20%
- Only 14% of the time did the market finish worse than -10%
- Less than 5% of the time did the market finish worse than -20%
- The market was 5 times more likely to be up 20% or more in a year (50 out of 189) than down 20% or more (just 9 out of 189)!
Lessons learned from past markets:
- No one can consistently predict when market declines will happen.
- No one can predict how long a decline will last.
- No one can consistently predict the right time to get in or out of the market.
- The historical odds of making a gain in the market is good.
- The historical probability of losing money in the market on any given calendar year is low.
Investing and Emotions
In economics and decision theory, loss aversion refers to people’s tendency to strongly prefer avoiding losses to acquiring gains. Most studies suggest that losses are psychologically twice as powerful as gains. I’ve studied loss aversion in the classroom, taught on loss aversion in an academic setting and lived through how this plays out for investors during market declines. In short, emotions have the potential to destroy an investor’s ability to achieve their financial goals.
In an annual Dalbar study, the research firm stacks up investor returns vs. those of stocks and bonds. The study, published in early 2015, looked at returns from 1995-2014 which showed the stock market averaging 10% per year for the previous 20 years where the average investor returned around 2.5% – just a hair over inflation. Much of this underperformance can be attributed to overly confident investors purchasing when the market is reaching new highs and panic-stricken investors selling when the market declines.
Lessons learned from emotions and investing:
- Have a well thought out financial roadmap.
- Review the roadmap during both good and bad market cycles.
- Ask yourself, “Other than my emotions and the market, has anything changed with my financial plan and goals?” If not, stick to the plan. If things have changed, let’s talk.
- Historically, selling investment to relieve anxiety about the markets can be costly.
We know the markets will surprise us. The consensus estimates of “where the market will go and why” are most often wrong. History will not repeat itself in the market the same way, but we can learn a lot from both historical data and behavior.
When the market is volatile, particularly when it’s in decline, it can be unnerving for many investors. The concept of “buy and hold” never sat well with me. I prefer “invest and assess.” Whether in stocks or bonds, investing has to be with a purpose and a plan – period. Our team’s work is to serve you by synthesizing your information into a plan with a purpose. Having the plan in place, we practice “invest and assess” with the goal of offering you confidence in how your plan will play out both in and through retirement.