I sent out an email to my clients today telling them why they shouldn’t panic in face of the recent stock market volatility. I”m sure many people are nervous after three large down days in a row, so I thought I’d post a copy of the email I sent out below:
I just wanted to check in with you. If you’ve been around me for a while, you know I tell people not to watch the market on a daily basis. However, I know its human nature to do so anyway, so you have probably seen the news that US stocks fell sharply lower last week with the Dow losing 800+ points on Thursday and Friday. While it never feels good to see stocks tumble into the red, it is by no means time to panic. Here’s why:
- The market moves in cycles. While we all would like to see our portfolios go up all the time that just isn’t how the market works (nor is it realistic!). Having said that, it’s important to note that since 1900 there have been 35 declines of 10% or more in the S&P 500. Of those 35 corrections, the index recovered fully within an average of 10 months.
- The S&P 500’s average annual total return over the past 50 years is 10%. This is even with large corrections such as those that occurred after 9/11 and during the 2008 economic recession. As you know, I use a pretty conservative rate of return in your retirement projection (6-7%), so your plan should still be solid even with the current market volatility.
- We’ve been in a very strong bull market the last five years or so. The S&P 500 more than doubled in value from March 2009 through 2013 with annualized returns of more than 20% through the end of 2014. Knowing that, I have been telling clients that a correction is overdue, if for no other reason than to bring market values back down to “normal” levels. So a correction this year was certainly not unexpected.
- However, the volatility of the past few days has been greater than expected for a “reversion to the mean” type of correction. This has been due to a combination of events including China’s devalued currency, speculation over the Fed’s plans for US interest rates, declining oil prices, ongoing uncertainty in Greece, and so on… Each of these factors on its own can have an effect on the market; combined, their impact has been more dramatic. Even so, none of this news was entirely unexpected.
- Key US economic factors (manufacturing orders, housing starts, auto sales, P/E ratios, etc.) remain strong, which is why most analysts are viewing this week’s activity as a correction rather than a bear market. This means from an investment perspective, this may be a great buying opportunity rather than a time to sell.
- If economics and history repeat themselves – and to date they haven’t failed in this regard – the market will rebound, and long-term investments will continue to provide value.
So what should you be doing now?
- Make sure you have a portfolio that matches your risk tolerance, time frame and goals. This has always been my highest priority, so if you’ve been in for a review recently, your portfolio should already match these goals.
- Rebalance your portfolio annually. This ensures that you don’t become over-weighted in any one asset class, thus putting your portfolio at greater risk during a decline.
- Keep adequate liquid funds to cover living expenses (if retired) or emergencies (if still working). A good rule of thumb is to have 3-6 months of living expenses set aside if you are still working, and 12-24 months of living expenses set aside if you are retired or close to retirement.
- And finally, don’t panic. People who try to time the market lose on average 50% more than people who stay the course. This is because when you sell after a large decline you are locking in your losses with no way to recover them.
If anything shifts to change my thinking, I will let you know right away. But for now, I urge you to sit back, relax and enjoy the rest of this beautiful day. If you are too concerned about the immediate days ahead, please send me a note and I’ll be happy to address your concerns individually.
In the meantime, turn off the TV and don’t listen to the talking heads screaming doom and gloom headlines (remember, they are emphasizing the negative in order to keep people watching). Practice patience and assess your own comfort level in weathering what may be some choppy days ahead.
All the best,
P.S. Here is one of my favorite graphs regarding stock market volatility:
As you can see from this graph, market declines are normal with a 94% chance that a 5% decline will happen in any given year, a 59% chance of a 10% correction every other year, a 21% chance of a 20% decline every five years, etc. Based on these probabilities and the unprecedented returns we have seen in the S&P 500 over the last five years or so, we are actually long overdue for a correction. While that may not be very comforting, it’s important to put historical market corrections into perspective and to understand that corrections are a normal part of the stock market.