If we go back to the late 1920s and 1930s depression, the Dow Jones Industrial Average was much lower. Even before the great "crash" in the stock market, the Dow was about 300. In two successive days in late October, 1929, the stock market fell more than 24% over a two day period. Such a decline today would be the equivalent of about 3,000 points in the Dow. That index would eventually fall to just 41 on July 8, 1932, a stunning 89% drop over a three year period. The equivalent at today’s levels would be a decline in the Dow Jones Industrial Average from about 12,000 to under 1,500.
During this recent market downturn commentators pointed to the large point declines in market averages to underscore the high levels of volatility, but again this is only because the stock market is now so high, compared to its more than 100-year lifespan. Of the twenty largest daily Dow point declines, nineteen of them occurred just in the last 14 years (the 1987 Black Monday decline was the only earlier decline to make the list). But in terms of percentage declines, only six of the twenty largest declines occurred since the mid-1990s (four of these six were during the sharp market declines in the fall of 2008). And despite the sharp market downturns over the past two weeks, none of them made the list of the top twenty largest percentage declines.
Volatile markets are very difficult emotionally, for individual investors, traders, professional mutual fund managers and advisors. However, volatility is the price of admission for entrance into the financial markets. And not just to the upside, where it’s pleasant, but to the downside too. But in the long run short-term volatility rewards long-term investors because it generally leads to higher long-term returns compared to “safer”, less volatile investments.
Thankfully there are things that investors can do to lessen the volatility of their financial holdings. The first is to simply hold a smaller percentage of their assets in risky assets like stocks. For example, instead of keeping 90% of your money in stocks you could keep 20% or 30%. But such a strategy leads to another risk, that your money won't keep up with inflation. Especially for younger investors decades from retirement, holding too much in “safer”, low-yield investments can lead to lost wealth due to the ravages of inflation. Five percent yearly inflation will lead to a doubling in living expenses in 14 years and an increase in costs of living of more than ten times as high over a 50 year period.
In the shorter term, investors can ensure they’re adequately diversified, which will decrease short-term volatility. Diversification includes U.S. stocks, foreign stocks, bonds, cash-type investments, and possibly real estate and commodities such as gold or silver, industrial metals or agricultural products. For example, during this latest stock market downturn, bond investments did very well as well as gold. Those two types of assets tend to zig when stocks zag, helping reduce the volatile of an investment portfolio.
Lastly, investors need to control their investment expenses. Although expenses take their toll during up markets as well as down, in the long-run, they detract from overall returns and amplify down market returns. Low-cost investments should nearly always be utilized when available and efforts should be made to keep trading costs, management fees, and broker fees (commissions) as low as possible while still achieving proper diversification.
For younger investors who intend to continue investing for many years, down markets should be considered opportunities to buy stocks “on sale”, with the eventual payoff down the road. As long as a portfolio is reasonably diversified, market downturns should not lead such investors to panic and pull the plug on their retirement strategy.
I expect the current stock market volatility to continue for a while. There is much uncertainty in the economic and financial world about debts, government intervention and economic growth. And if this current market downturn is more lasting, it’s also worth remembering that bear markets don’t last forever, typically a year or two. If we remember back to the sharp bear market from 2000-2002 in which case many market averages were cut in half, most diversified investors who stayed the course were rewarded over the next five or six years as the market made a sharp rebound.
Despite the problems in the U.S. and Europe the worldwide economy is still growing and companies that can deliver successful products and services to these growing economies and the growing middle-class will prosper. Investors participating in this global growth will be rewarded, in due time.