Straight Talk About Volatility In The Stock Markets
Throughout the history of the stock markets, many investors tend to react to short-term market volatility in the same way. When the markets go up, we all tend to pile in our money, hoping that the good times will continue indefinitely. When the markets go down, many of us tend to sell our investments out of fear that the downward spiral will continue indefinitely. Not the best way to make money, right?
I want to give you some straight talk about the volatility of the markets in the hope that you will clearly understand the characteristics and be better educated before you make decisions to sell your portfolio when the markets go down. I will also show statistics that you need to know before making any investment decisions. I will then show you what these numbers mean and what you should consider before making an investment decision.
Let’s consider two different portfolios, one with 100% in Canadian equities, properly diversified and the second one being more balanced with 60% equities and 40% bonds. Let’s also consider four timeframes for these portfolios; 1 year, 3 years, 5 years and 10 years.
1-Year Period
If you invest in 100% equities, again, properly diversified and you simply bought the markets, let’s say, using Exchange Traded Funds (ETFs), the best one-year return that has ever been produced is a whopping 86.9% (June 82 - June 83). The worst year ever produced was around -39.2% (June 81 - June 82). As you can see, the gap is huge. A balanced portfolio’s best 1-year performance was about 59.1% (June 82 - June 83) and the worst 1-year performance was – 24.4% (Sept. 73 - Sept. 74).
3-Year Period
For a 3-year period, the best return for 100% equities was 39.3% per year, on average (Nov. 73 - Nov. 80) and the worst 3-year period was -11.1% per year on average (Aug. 00 - Aug. 03). For a balanced portfolio, the best 3-year period was 27.8% per year on average (June 82 - June 85) and the worst 3-year performance was -5.5% per year on average (Mar 00 – Mar 03). As you can see the volatility has dropped significantly over a 3-year period.
5-Year Period
100% equities: Best period returned 27.8% per year on average (July 82 - July 87) and the worst period delivered -1.9% per year on average (Mar. 98 - Mar. 03).
Balanced: Best period returned 25.3% per year on average (June 82 - June 87) and the worst period delivered 0.2% per year on average (Mar. 98 – Mar. 03).
10-Year Period
100% equities: Best period returned 19.5% per year on average (Aug. 77 – to Aug. 87) and the worst period delivered +2.8% per year on average (Aug. 00 – Aug. 10).
Balanced: Best period returned 17.0% per year on average (Aug. 77 – Aug. 87) and the worst period delivered +2.3%% per year on average (Aug. 00 – Aug. 10).
There is some extremely interesting and useful information coming out of these numbers. First, you should never put your money in the stock market if you will need it within one year. I don’t think I’m telling you anything new here that you don’t already know. Both 100% equity and balanced portfolios can potentially fall dramatically. However, if you look at the 5-year number for a balanced portfolio, the worst 5-year period is +0.2%. This means that a balanced portfolio has never had a negative 5-year period. The worst that you could have done as an investor is break even. The 10-year numbers are even more interesting. If your money is invested in 100% Canadian equities and well diversified in an ETF, the worst 10-year period was 2.8% and a balanced portfolio’s worst outcome was 2.3%
All this to say that one year periods can scare the heck out of investors. If you cannot stomach the short-term pain then you should not be in the markets. However, if you can digest the ups and downs then the volatility goes down significantly. Just remember this: A balanced portfolio had never lost money over five years and even a 100% stock portfolio has never lost money over ten years. Keep these numbers in mind when the next inevitable downturn comes.
John Kalos , CFP, Fin.Pl. is an independent Certified Financial Planner and founder of Merit Financial Planning. He is also the founder of "Confessions of an Ex-Banker" Podcast.