Unlike last year, the stock market has had a very bumpy ride through the first quarter of 2022. Investors are on-edge about lingering inflation, climbing oil prices, tighter monetary policy by the Fed, and Russia’s invasion of Ukraine, as well as other geopolitical tensions. These events raise uncertainty and expand the market’s probable range of outcomes. As a result, sporadic trading activity causes elevated volatility in prices, which can bring angst to even the most experienced market participants.
However, making drastic changes to your portfolio during a turbulent market is akin to rebuilding a ship that is already out at sea in the middle of a storm. Just like the ship, the portfolio was designed to handle rough seas and the ship’s crew trusted it to do so before leaving the port to set sail. Once a storm breaks out, the crew is instructed to “Batten down the hatches!”, meaning try to keep the ship together and stay inside.
The crew would be ill-fated to begin making renovations to the ship in such harsh conditions. Survival becomes the main objective, and no major changes to the vessel should be made during this time. An investor’s best defense is demonstrating discipline and “riding out the storm” aboard their diversified portfolios that were built to handle these situations.
These “sea storms” or bouts of volatility are much more common than you would think. Dating back to when price data was first being recorded, we have learned that volatility is a normal condition of markets and not a malfunction of them. Research from Charles Schwab shows us that intra-year declines in the S&P 500 Index are routine for investors to endure during any calendar year.
Over the last 20 years, the market has had a correction of at least 10% in 10 years, or 50% of the time. The most recent occurred last month in February, which was the most severe decline since the 34% drop in 1Q20 triggered by the COVID-19 pandemic. Furthermore, investors have endured bear markets (defined as 20% declines from recent highs) in 4 of the last 20 years, or 20% of the time. If we count the number of corrections since 1974, 80% of them did not exacerbate into a bear market. Interestingly, markets have seen a standard 5% pullback in 18 out of 20 years yet have realized positive returns in 17 out of 20 years.
It is important to note that both up and down market volatility tends to cluster together, i.e. large up moves and large down moves typically occur within days of each other. Trying to time the market by selling your investments and moving to cash in anticipation of a pullback almost always leads to omitting recoveries and increases. Plus, guessing re-entry into the market is an absolute quandary, even for professionals.
The latest bull market lasted 11 years and brought a total return over 400% to those who stayed invested. Following the bottom caused by COVID, the market advanced more than 100% in less than 2 years, marking the shortest bear market ever, which lasted just 1 month. Someone who remained invested in the S&P 500 Index for the full year achieved an 18.4% return for 2020. However, if an investor sold out in mid-March, they risked locking in a loss in excess of 30%. This observation is not exclusive to the year of COVID.
Schwab’s research shows that missing the Top 10 trading days in 2020 would have returned -32.9% to an investor, since many of the biggest up days were mixed into the same short time frame as the biggest down days. Over the last 15 years, an investor who employed a “buy-and-hold” strategy (i.e. remained fully invested) grew their wealth by an annualized return of 10.66%. Whereas those who missed the top 10 up days during that time would slash those returns in half to just 5.05% annually. Even worse, missing the top 30 days brought annualized returns into the red at -1.18%.
Market volatility can ignite fear in even the most rational investors and induce them to act on their emotions and make irrational, impulsive decisions. Picture the chaos that ensues when someone yells “Fire!” in a crowded building or “Batten down the hatches!” on a ship out at sea.
During these crises, those who can suppress their own fears and emotions are able to remain calm and employ logic to create an intelligent plan to make it to safety. Congruently, when it comes to investing, the best plan of action is often inaction and exercising the discipline needed to remain invested in your diversified portfolio.
One of the most common mistakes investors make is to sell during times of panic after markets decline, which locks in losses and causes them to miss out when markets rebound (and advance higher). As you should already know, your portfolio was carefully designed to handle turbulent situations, which is why you were comfortable enough to invest your money there in the first place.
We hope this serves as sound evidence that trying to time the market is very dangerous and how sticking to your long-term investment plan produces better outcomes. During periods of uncomfortable volatility, maintaining the discipline to stay invested is vital to achieving your financial goals.
The RMR Investment Committee