What a difference a month can make. At the end of June, I shared some pretty grim market numbers from the first half of 2022.
It was one of the worst ever six-month periods for U.S. stocks and bonds. South of the border, stocks dropped 20%, falling into bear market territory, while bonds were down 8.8%, the biggest decline in four decades. In Canada, stocks were down 9.9% while bonds were off 12.2%.
Then, the markets rebounded powerfully. As of August 18, the U.S. stock market had recovered 13.2% in U.S. dollars while Canadian stocks had gained back 7.4%. The Canadian bond market gained 2.6 % in that same period.
The turnaround may seem surprising but actually, it isn’t unusual, judging by the historical market data presented in a recent webinar from Dimensional Fund Advisors. The webinar highlighted the fact that stock market declines of 20% or more occur fairly regularly and so do bounce backs.
Between 1979 and 2021, intra-year declines in the U.S. stock market averaged 14% from peak to valley. In 10 of those years, the drop was 20% or more. However, when looking at the market history of annual returns, only 8 of the last 46 years were negative.
So, at some point in a year you’re going to have a decent correction if not a bear market, but it doesn’t necessarily mean the year will end in negative territory. That’s why it’s so important to prepare yourself for market declines and not give into fear during those episodes.
The last time we had a first half as bad as this year was in 1970 when the S&P 500 lost 21%. Today’s investors can imagine just how gut-wrenching that must have felt. But in the second half of that year the market rocketed 29% higher and the S&P 500 finished the year at +4%.
Investors who sold their stocks that year because they feared more losses would have ended up missing on a huge rally and gain for the full calendar year.
Indeed, trying to time the market by jumping out to avoid losses and then getting back in when things appear calmer is often a very costly mistake as Dimensional demonstrated in another chart presented during the webinar.
It shows that had you stayed invested in the U.S. market during the 25-year period from 1997 to 2021, $100,000 would grown to slightly more than $1 million, or 10 times your initial investment.
Of course, it wasn’t all smooth sailing during those years. There were many times when you could have become spooked by a market decline and decided to go to cash.
If you had and missed out on the best month during this period, your returns would have melted to $865,000. Had you missed the best three months, you would have earned just $731,000.
And as the presenters remind us, you would have also given up a lot of peace of mind. It can be just as stressful to be out of the market when it’s rising as it is to be in it when it’s falling.
Now, I’m not predicting that when the end of 2022 rolls around the stock market will show a positive return for the year. We don’t know what’s going to happen between now and then.
However, the reason we earn returns from stocks and bonds is because we are willing to accept a measure of uncertainty and risk in return for the expectation that returns will be positive over time.
And while positive returns don’t come every day, the longer you are in the markets, the more you should expect positive returns. Therefore, the antidote to volatility is to stick to your financial plan and keep focused on the long-term.
As we saw last month, the markets can turn quickly and rise substantially in a short period. To capture those returns, you must be invested.
I encourage you to watch the full Dimensional webinar where not only bear markets but also inflation and recessions are discussed. And be sure to listen to our Capital Topics podcast for more insights into evidence-based investing and personal finance.
Sources: Quotestream and Dimensional Fund Advisors