"Dow Industrials plunge more than 1,100, the biggest one-day point drop ever..." was a headline after the market closed today. Why lead with the point decline and not the percentage decline? A 4% drop isn't nearly as alarming, and you might be less inclined to click on the headline.
On a day in October of 1987, the Dow dropped 23% -- about six times as much as today's decline. Almost a quarter of stock market value was temporarily wiped out in eight hours after a loss of 508 points. If we had experienced the percent loss at that time which we saw today, the Dow would have only gone down 80 points -- there would be no such thing as "Black Monday." But the Dow was approximately 1,700 in the late 1980s, a far cry from the 27,000 level we reached earlier this year. A 1,000 point drop would be catastrophic when the Dow was 1,700; today it's just a blip. Said differently, 1,000 points ain't what it used to be.
How much of a blip was today's move? The chart above shows the annual returns on the S&P 500 every year since 1980. The red number at the bottom of each year lists the maximum, intra-year decline. We forget how volatile stocks are in the short run because the long-term trend is relentlessly positive and returns are so impressive. Despite the fact that the S&P 500 was positive in 28 of 37 years between 1980 and 2016, it experienced a drawdown from its peak every single year. On average, the intra-year decline on the S&P 500 was -14.2%, ranging from just -3% to -49% in 2008. One way to interpret this data is that you should expect to lose at least 15% of your stock portfolio at some point throughout the year, every year. Any year where the maximum peak-to-trough decline is less than -14%, like last year, is a less volatile year and shouldn't be expected to persist.
Of course, I can't discuss short-term losses without also pointing out the long-term returns on the S&P 500 over the 1980-2016 period. The "gain" you received for putting up with the unpredictable short-term "pain." The average return on stocks over this period was +11.5% annually. $1 in the S&P 500 was worth $56 by year-end 2015. In a globally-diversified portfolio (see Dimensional Equity Balanced Strategy Index) you would have done even better -- ending with $114 because of 2% a year higher returns. But what if you decided to avoid these unpredictable but inevitable short-term declines and invest in risk-free Treasury Bills? You would have earned just +4.4% a year and your $1 barely reached $5. Looked at through this lens, temporary stock market declines or significant one-day drops are not something the long-term, growth-oriented investor should worry about or try to avoid. The very presence of the short-term volatility is one of the reasons long-term stock returns are so high. Without the short-term losses, returns would be much lower and unlikely to allow you to achieve your long-term goals. You might not like the stock market volatility, but you cannot be successful without it!
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.