Longest Bull Market? The importance of staying the course
The current bull market rally in the stock market recently became the longest in history. This fact and the market’s nearing all-time highs could begin to create angst among investors. Many may feel like more volatility could be lurking right around the corner. Of course we’d all like to avoid market declines, however no one can predict with any accuracy when those will occur. It’s impossible to predict the future but expecting dips in the coming months and years is likely a safe bet. But it’s important to be mindful about how to deal with portfolio volatility. As a swift change of course could have a catastrophic effect on your longer-term investing success. However, remembering these simple principles should help smooth out the ride.
Remember volatility is normal.
Volatility in the stock market is very normal. And feeling uneasy about a lower portfolio value because of that volatility is a normal part of human nature. Over the past 88 years, investors have experienced moderate pullbacks of 5% roughly once a quarter on average. Even in years with outstanding equity returns, there are bouts of volatility. What we cannot show in the below chart is the seasickness an investor feels while riding these waves of volatility to temporarily lower portfolio values. Focusing on the long-term trends of the market rather than the short-term gyrations should give investors the confidence to ride the waves of volatility. And those trends historically have been quite positive. On average, the stock market has generated a positive return more than 70% of the time when looking at one-year periods.
Stay the course.
Frequent dips in the market can be unsettling, and can encourage market timing, but investors should not jump ship. Being fully invested is particularly important when there is market volatility, because the best and the worst days in the market tend to be clustered together. If you were lucky enough to miss the worst days, you also were very likely to have missed the best days.
The chart below illustrates the impact on investment performance of being out of the market on the very best days over 20 years. An investor who didn’t jump out of the market and stayed in a fully invested portfolio would have returned nearly double a person that missed the 10 best days in the market. Additionally, as the majority of the best days occur within two weeks of the 10 worst days in the market, it is likely that investors who sold equity because of seasickness after a bad day often also missed a big rebound. Staying the course through bouts of volatility can have big payoffs.
Diversification smooths the bumps.
Portfolio stability can be managed through effective diversification. Although economists have a positive outlook on the U.S. for the coming year, other international market's equities can give your portfolio both exposure to growth and risk factors outside the U.S. economy that may help boost returns and lessen the dips. While a combination of various asset classes should improve portfolio returns, diversification is most valuable for keeping a portfolio on an even keel.
Diversification has been shown to improve the risk/return profile of an asset allocation portfolio relative to just U.S. equities over the past 20 years. This means investors in a diversified portfolio sailed through market volatility feeling fewer waves. The reason why is that differing investments zig and zag at different times. This combination of investing in different asset classes tends to work well to smooth the bumps.