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Extreme Stock Swings Are To Be Expected

March 09, 2020
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Investing is about achieving long-term financial goals: a comfortable retirement, an ongoing income stream that grows faster than inflation for several decades, and a plentiful inheritance for beneficiaries.  Right away you should recognize as a long-term investor that daily, weekly, or monthly market returns are totally irrelevant; it's your return over many years that matters.  If your money was earmarked for near-term needs you wouldn't invest it; you would keep it in a savings or money market account.

Yet counterproductively, we are often drawn to short-term market moves, especially when the swings are extreme.  In the worst scenerios, we watch stock returns and track our portfolio returns daily!  This has nothing but a negative impact on our financial sanity and wellbeing.  

If certain stocks or sectors are soaring, we are prone to chase returns and try to capture more of the significant surges while giving up on underperforming parts of our portfolios. When markets are plunging, we feel the urge to bail out to avoid even greater potential (temporary) losses.  We shut off our automatic investment plans or we let cash that was earmarked for investing pile up in our savings accounts earning almost nothing.  

What compounds our feelings of greed and fear is the belief that "this time is different."  Especially when stocks experience big declines, we feel like we're in uncharted territory, as higher stock market levels result in greater point moves.  But extreme percentage stock swings are to be expected; they've always been part of being a long-term investor and achieving the significant gains that stocks have offered.

Consider the chart above that tracks daily S&P 500 Index returns from 1990 to 2018 -- a period of almost three decades.  The vast majority of the time, daily returns cluster within a very narrow band (highlighted in grey).  Day-to-day returns are boring.  But occasionally, extreme gains and losses happen.  Here's what the data says:

  • Losses of at least -3% in a day have happened on average three times per year; gains of +3% in a day have also happened about three times per year.
  • Losses of at least -5% have happened every two years, gains of at least +5% have also happened every two years.
  • Losses of at least -7% have happened once every seven years, gains of at least +7% have happened once every ten years.
  • We didn't see a loss of -10% or more for stocks in this period (we saw -20% in 1987), but we experienced a daily gain of +10% or more in stocks twice -- once every 14 years.

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Now the hard part -- extreme stock swings aren't as evenly distributed as the odds suggest, happening just once every year or every few years.  Stock gains and losses tend to be clustered -- big declines and big gains often happen in close proximity.  Then they disappear for years.  What this means is that when stocks start moving wildly, you should expect that to continue for a while.  But the wild swings aren't just losses, they include gains as well.  If you bail out after a loss of -5%, -7%, or -10%, you're more likely to miss the counterbalancing gain of +5%, +7%, or +10% that eventually materializes!

So why would you put up with such extreme market moves, even once or twice a year?  Here's where our emphasis on the long-term really pays off.  We expect and accept extreme stock swings because the long-term returns have been so lucrative!

Over the period from 1990-2018, a stretch representative of an investor's entire retirement savings or retirement spending horizon, stocks experienced a number of dramatic downturns, but still produced exceptional growth of wealth.  As the table below reports, stocks didn't achieve double-digit gains because they avoided significant losses.  They did so in spite of the fact that they occasionally lost significant value!  Without the losses, we wouldn't have experienced the significant gains.  

From 1990-2018 stretch, $1 in the S&P 500 grew to $13, almost $18 in an index of large cap value stocks, over $24 in an index of small cap stocks, and over $37 in an index of small cap value stocks!  This accretion of wealth is unprecedented in any other mainstream investment category.  But the only way to earn this result, or something similar over the next few decades, is by hanging in there during rocky times.

The market swings of today seem extreme, but they are to be expected.  Stocks behaved similarly in 2018.  We saw another episode like this in 2015 and before that in 2011.  This is part of the process of earning high long-term returns.  The best thing you can do is to trust your investment plan, continue to invest when savings become available, and spend within your limits if you're retired (selling stocks during bull market and spending from bonds in bear markets).  Most of all, don't panic, and stop looking at headlines and your portfolio values daily.  There's no way to make a temporarily difficult period worse than studying it and obsessing about it continuously.  There's much more to a happy life than stock returns.  

My advice: take a break from your portfolio for the next few weeks at least, and ideally the next few months.  I bet you'll be happy you did.

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Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.