While 2017 was essentially a slumber party with markets marching strictly forward, the first quarter of 2018 has been more like a pillow fight. Daily 300-point swings in the major indices have been commonplace. The media (who are perennially clueless) make up reasons every day for the volatility. “Talk of Trade War Tanks Markets”, screams one headline. “Rate Rise Sinks Bonds”, shouts another.
Rather than trying to pin blame for the market gyrations on something, we wish the media would simply tell the truth: That market volatility is perfectly normal. Not only that, it’s absolutely necessary if you want to grow your wealth. Allow us to explain:
First off, it should be obvious to anyone that investing in things that don’t fluctuate in value means you don’t earn anything. Take bank accounts, for instance. Your principal is protected, meaning you’ll get back exactly what you put in (plus maybe 0.3% interest). But inflation running at 2-3% means the principal you get back won’t buy as much as it would have a year ago. (So you actually lost money.) The only way to grow your wealth is by investing in stuff that fluctuates -period.
Second, the word “volatility” has been incorrectly beaten into you to mean a sudden downward move in markets. When stocks shot up 25% between the 2016 election and the end of 2017, not a single news outlet called it “volatility”. But when it declined 10% in a matter of a week in January, the papers screamed “The Return of Volatility.”
Third, most people equate the term volatility with loss. But that’s not correct. Fluctuations in value are only temporary. Loss is permanent. So let’s replace the word “volatility” with “fluctuation”. Try it: “Market Volatility Returns” versus “Market Fluctuation Returns”. They are both true, but which one sounds more accurate if the activity is temporary? And while we’re at it, a history lesson. Let’s go back as far as you like – you pick the year. Go ahead – we’ll wait. Now, a question: How many times throughout your chosen period have markets declined and stayed down permanently? Let’s ask the question a different way. How many times in history have markets declined, only to recover and move on to new highs? The answer is 100%. If history is any guide at all, this time will be no different.
Throughout the history of today’s equity markets, stocks have temporarily declined on average between 10% – 14% each year during the year sometime. And every five or six years, stocks temporarily decline about twice that much. The reward for this temporary fluctuation equates to an average annual return on stocks of around 10% over the long term, or about 7% per year higher than annual inflation. That’s about twice the return you’d get in corporate bonds. And it’s all due to volatility. (Let’s face it – if the declines went away, so would the advances.)
If the above is true, perfect logic would suggest we should have 100% of our money in stocks, correct? Not really. Most people simply can’t stand to ride out the ups and downs of stocks alone, particularly if they’re in retirement. The solution is to own some stocks, but diversify into other investments such as bonds, real estate, etc. This means we won’t earn as much as we would if we just owned stocks, but we also won’t experience the same level of fluctuation. Being diversified means you don’t make a killing, but it also means you don’t get killed.
None of this means people shouldn’t feel uneasy when markets see-saw back and forth. Feeling a bit nervous is quite natural. But it’s another thing entirely to act on that nervousness. If you’re properly invested in a diversified portfolio, don’t change your investments. Instead, change your vocabulary.
As always, don’t hesitate to call us if we can be of any assistance. See you next quarter.