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Volatility in Perspective

Posted by Jeremy Merchant on Sep 1, 2015 5:00:00 PM
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Market volatility has recently increased after several years of calmer markets. Today's market action was another example of recent increased volatility. Concerns over China, global geopolitical concerns, Eurozone issues, central bank policies and the duration of today's business cycle are just a few of the reasons for the dramatic market swings. History notes that as volatility increases, there is a direct correlation to investors that inappropriately try to market-time their portfolios around market volatility. Investors who do not maintain focus on long-term economic and market expectations often achieve sub-par results.

As we all know, volatility in investing is sometimes unavoidable. However, having the discipline to stay invested during these periods has often been rewarding. For example, the max intra-year drawdown of 5.8% in 2013 (when the Fed began hinting at reducing asset purchases) was concerning. In October 2014, due to worries over international markets, the market experienced an intra-year drawdown of over 7%. Despite these negative market reactions (and volatility), neither episode was in reaction to underlying long-term economic trends. Not only did the market recover in each case, but these (2013 & 2014) intra-year pullbacks ranked as two of the shallowest on record in the past 87 years. Within the graphic below, note the intra-year drawdowns versus their respective calendar year S&P 500 Index returns. In this graphic, we can see that despite an average intra-year decline of 14.2%, annual returns were positive in 27 of 35 years.

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Certainly markets can be volatile in the short run. Historically, markets have pulled back 5% or more an average of four times per year. In fact, every year since 1995, we have seen at least one 5% pullback! Despite these short-term pullbacks, markets have tended to recover. Within the graphic below, we can see the frequency of short-term market pullbacks by calendar year.

 

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Response to Volatility

History also notes that positive days more than offset negative days within the market. While market timing may be alluring to investors attempting to avoid short-term losses, doing so ultimately fails since gains occur more often. Remember, timing your assets out of the market also requires you to make a decision on when to get back in. Statistically, it's a game that leads to sub-par results.

It should also be noted that short-term volatility is smoothed over longer term periods. For every one-year period from 1950-2014, the S&P has experienced extreme gains and losses (like in 2008 when it was down 37%). However, if we expand our time horizon to a 5-year holding period, we note that there are fewer periods in which the markets experienced negative returns. Looking at a 10-year window, we note that only after the Great Depression (1938-1942) and again after the "Great Recession" (2008-2010) did we experience negative returns over a 10-year period in the S&P 500 Index.

We believe that history shows that staying diversified, rebalancing properly and setting asset allocations that account for long-term economic and corporate fundamentals is the best way to achieve long-term investing success and combat market volatility. 

We can be reached at 800-321-9123 with any questions you may have.

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Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by RAA following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, RAA accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security. 

Topics: Investment Updates