Market Volatility

Your investment horizon matters.

When markets are choppy, this can make some investors nervous. But unless your investment horizon is shorter than 10 years (for example, because you’re nearing retirement), you’re probably a long-term investor and likely have time to ride out the storm.
In other words, if market volatility doesn’t have the potential to compromise your retirement income, you can probably afford to accept the ‘downs’ and stay put. Just check that your risk profile hasn’t changed and that you’re invested accordingly: if so, you can probably trust your plan and focus on the long haul.

Markets have always recovered.

There’s nothing quite like historical data to help put recent market volatility into perspective. Take bear markets and bull markets in US history, for example.
A common technical definition of ‘bull market’ is when the market increases at least 20% from a recent bottom. Its counterpart is a ‘bear market’, when the market drops at least 20% from a recent peak.
Now, looking at the table below, you’ll see that since the Great Depression of 1929, the S&P 500 has experienced 26 bear markets, not including the current one.

Source: Ned Davis Research, 12/21.

And here’s the important bit: in the same period, there have also been 27 bull markets. What’s more, bear markets lasted on average 289 days (9.6 months), while the average length of a bull market was 991 days (2.7 years).

Of course, past performance is never indicative of future performance – but it’s still a pretty strong indication of how market cycles work. No one knows how the market will move next, but if you give it time, it will likely recover.

How to befriend volatility

Remember: drops in value are not real losses until you sell your investments or withdraw the money, crystallising the loss.
Many people think that they need to protect their savings from volatile markets, maybe ‘hiding’ them in lower-risk investment options. But again, unless retirement is around the corner, by doing so you may actually miss out on further growth opportunities – and potentially put a dent in your financial future.
So, managing volatility is not about protecting savings. It’s about mitigating but also taking advantage of risk to grow your savings in the long run. In fact, trying to avoid the worst days may mean missing out on the best days: according to Ben Nevis research*, half of the S&P 500 Index’s strongest days in the last 20 years happened during a bear market.
There is a phrase we commonly use when talking to clients about volatility: ‘time in the market’, not ‘timing the market’, is the recipe for long-term investment success.

Good reads to learn more

If you’re looking at delving a little bit deeper, here are some good reads we recommend:

• Six months are responsible for all of the gains in the US stock market since 2000 (OfDollarsAndData.com) – In this compelling article, Nick Maggiulli from Ritholtz Wealth Management LLC highlights just how difficult it is to pick the ‘best days’ in the market. So, the best way not to miss them is to stay invested as much as possible.
• What if you only invested at market peaks? (AWealthOfCommonSense.com) – Meet Bob, the world’s worst market timer. Financial planner and blogger Ben Carlson imagines how things would go down for Bob if he tried to invest only at market peaks.
• One more prediction for 2023
  (AWealthofCommonSense.com) – “The stock market will have a correction in 2023” is not really a prediction, but more a ‘safe bet’ as the share market has a correction every year. With handy graphs and data, Ben Carlson tells us that risk is easier to predict than returns.

Longevity risk

Inflation can also impact the value of your savings, because it erodes your purchasing power over time.
It’s important to note that inflation risk is always there, not just when inflation is high (like the current levels of over 7%). In a well-performing economy, you may still find inflation at 2% or 3%, and even small increases in the cost of living can have a significant impact on the value of your money over time.
For example, with an average annual inflation rate of just 2.5%, a $4 carton of milk could end up costing almost $7.25 after 25 years. It’s easy to see how this can be a problem for retirees: as the cost of goods and services increases, a fixed amount of retirement savings will be able to buy less and less.
The solution is not just saving more. You also need to ensure that your savings are invested in a way to minimise or – better yet – outpace the effects of inflation. In other words, you need to invest at least some of your savings in assets that have the potential to grow faster than the inflation rate on average – like shares.

Sequencing risk

Imagine working hard and saving all your life, only to experience a significant market downturn just as you’re about to enjoy the fruits of your labour. This is the sequencing risk.
Timing is critical in retirement planning, and a run of negative returns close to retirement can be difficult to recover from. Also, withdrawals during market downturns tend to be more costly than the same withdrawals when markets are performing well.
While it’s not possible to control the performance of the share market, there are ways to manage sequencing risk. Both the dollar-cost averaging strategy and the ‘bucket’ (or cascading) approach are ways to mitigate this risk and withstand negative returns over time. Plus, don’t underestimate the power of diversification – which brings us to the next point.

Diversification risk

Let’s say you have a basket with all your eggs in it. If you accidentally drop the basket, you will lose all your eggs at once. However, if you have several baskets, each with a few eggs, and you accidentally drop one basket, you will still have other baskets with eggs in them, and your loss will be limited.
Similarly, if you invest all your money in one investment asset type, sector or market, and that performs poorly, you could lose a significant portion of your investment. However, if you diversify your investments across different types of assets and sectors, if one asset type or market performs poorly, the rest of your portfolio could balance out the losses.