Broker Check

5 Reassuring Facts about Market Volatility

| September 20, 2022
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1) Volatility may be uncomfortable … but it’s normal.

Just like muscle fatigue is part of any intense training program, volatility is an unavoidable part of the investment process as well. It’s easy for investors to forget that volatility is the norm, not the exception, when stock prices steadily rise or fluctuate less than 1% per day. According to market data, stocks have averaged three pullbacks of 5 - 10% per year, and since 1980 the S&P 500 experienced 25 corrections of more than 10%, and it has historically recovered. In addition to explaining the regularity of dips throughout a decades-long investment experience, it’s equally important to emphasize what typically happens in the period following a dip. According to Ned Davis Research, the average return from the lows after a correction exceeds 23% over the next year, which can be a comforting fact to investors who are seeing their account values drop. [Figure 1]

Additionally, we’re living in extraordinary times and while we haven't faced these exact economic and geopolitical issues before, the market has faced others and eventually, the turbulence ended positively. While it’s never pleasant to watch stock prices fall, if the investor can see it as an expected part of the investment journey, then the fluctuations may cause less angst. [Figure 2]

Figure 1

pullbacks are normal

Figure 2

LPL Financial Creative Graphic

2) Patient investors are typically rewarded

While investing in equities offers the opportunity to profit from innovation, economic progress, and compound growth, it also requires a lot of patience and time to pursue gains. Investing in the stock market is “a way for the impatient to transfer money to the patient,” as Warren Buffett famously once said.2

History shows that patience has indeed paid off:

Since 1990, the Dow Jones Industrial Average has achieved 9.5% annualized gains, including dividends. Even if you were to look at shorter time horizons since 1950 the S&P 500 has risen 83% of the time across a five-year horizon, 92% across 10-year periods, and 100% of all rolling 15-year periods. [Figure 3]

Figure 3

LPL Financial Creative Graphic

And while history cannot guarantee future performance, it can provide insight into the cost of prematurely exiting the market:

From 1990 to 2020, the S&P 500 Index’s annualized gain was 7.5% but the average equity investor’s return was only 2.9%.3 Why the 4.6% gap in performance? Because when stock prices begin to fall, investors become driven by fear, which drives them to sell even though it may not be in their best interest.

In addition to providing a long-term historical perspective, it may also help them to remind investors of their time horizon. Once they established a long-term goal, they embarked on a journey to pursue that goal. And although the journey may not always be pleasant, there are no shortcuts that allow them to skip over rough terrain.

3) Timing the market doesn’t work

Investors are naturally inclined to protect their portfolio from additional losses by selling on the slide and re-entering when they feel it’s a safe time to reinvest. And though it may seem tempting to time the market this way, it’s usually a costly mistake. Even the most seasoned investor can't predict when a stock has reached its peak or its bottom. During a market decline, if the investor sells out of fear of losing more, the decision of when to re-enter will be equally challenging because re-entering at the wrong time locks in the investor's losses.

From 1990 to 2020, the market's largest gains (and losses) occurred within days of each other. Despite "bad" markets, good days are more common than one might think. For example, consider geopolitical events. Stocks typically rise after negative geopolitical events occur, contrary to what most investors believe. Investors moving to cash on those days risk missing out on some of the market’s best days as stocks “climb the wall of worry,” as the old stock market adage goes.

For example, the annualized gain for the S&P 500 from 1990 to 2021 was 9.9%. Yet, if the investor missed only the best day of each year, that annualized return dropped to 6.1%, a difference of 3.8%. If they missed the best two days of each year, they would be up less than 3% annually. Taking it to the extreme, if the investor missed the best 20 days of each year, they would be down 24.4% per year. [Figure 4]

Figure 4

market timing costly

4) Opportunities are everywhere during volatility

When stocks decline, investors can buy in at a lower price and position themselves for future gains.  When the decline is part of an overall cycle, stocks trade below their intrinsic values and offer an improved price-to-earnings ratio.

When seen as an opportunity to buy valuable assets at fire-sale prices (when the market is down, investors can get more for their money on individual stocks and equities), investors can begin to reframe their experience and think of it from both the buying and selling angles. Selling may cause the investor to lose capital or to miss out on days where the market makes and holds on to its gains, whereas buying could position the investor better for long-term success.

5) Dollar-cost averaging (and other strategies) can smooth the experience

As investors may know from their experience investing in a 401(k), dollar-cost averaging can potentially reduce the overall impact of price volatility and lower the cost per share. While not as thrilling as receiving big gains over a short time, dollar-cost averaging can help investors maintain discipline during downward cycles.

Contributing the same amount of money into the same position on a regular basis, regardless of how the market is performing, is the opposite of trying to get in and out at the “right” time. As a result, dollar-cost averaging can be an effective and reassuring strategy for those who want to invest despite uncertainty. This can help avoid miscalculations in timing, remove emotion from the equation, provide a smoother investment journey, and help keep long-term goals in focus.

How can market volatility can help you?

While political, economic, and market uncertainties may cause your phone to blow up with texts, emails, and calls from clients, try to remember the silver lining. This is an opportunity for you to shine by helping investors establish realistic expectations, stay focused on their long-term goals, and maintain the discipline to reap the potential rewards. It’s also a great time to attract those self-directed investors who suddenly feel a bit less emboldened.

Perhaps you reach new clients who’ve been working with an advisor who doesn’t have a thoughtful investment process, or who lacks empathy, or may even be avoiding difficult conversations. These are the clients who are truly in need of your assistance, who will stay with you during future bull markets because you taught them the value of patience during volatility, and they can be your greatest sources for potential referrals in the future.

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