Seeing red? Look at the bigger picture
In this week’s Video Insight, I explain why market volatility is a normal part of investing. While market pullbacks can feel unsettling, history shows they’ve often been temporary and have regularly occurred even in years that finished with strong returns. The key is staying disciplined and keeping your focus on the long term.
Transcript:
If you looked at your equity portfolio this month and saw red… don’t panic. What if I told you that over the last 35 years, every single year the stock market has ended the year higher, it drops significantly along the way?
Right now, investors are worried about whether the Hyperscalers ever see decent returns on their AI capex, whether the Fed will hike rates, whether the Strait of Hormuz reopens before strategic oil reserves are depleted, and whether inflation can be contained.
But look at this S&P 500 chart. The blue bars show the full-year returns for the market. The red dots? Those are the biggest intra-year drops – or drawdowns – that happened along the way.
Notice the trend? The market ends in positive territory between 75 and 80% of the time. But in every single one of those positive years, the market suffered a temporary drop. In fact, the average positive year sees an intra-year decline of around 11%. And if we take out the 2020 Covid year, when the market plunged as much as 34% but then recovered to finish positively, every positive year still sees an average intra-year decline of 10%.
Volatility isn’t a sign the market is broken– it’s simply the price of admission for long-term growth.
Now, when the market does dip, people throw around a lot of scary words. Here’s the quick translation:
A Pullback is a drop of 5% to 10%. These happen all the time– usually a few times a year. They’re super routine.
A Correction is a decline of 10% to 20%. Intra-year corrections have occurred in almost every second year the market finished positively. So, while they’ll feel uncomfortable, historically, they’re just normal breaths taken by the market and are therefore great buying opportunities.
Finally, a Bear Market or Crash is a drop of more than 20%. This is the big one. It usually aligns with a recession, a major economic shock or a systemic threat to a system such as the financial system. But even here, historically, every single one has eventually been followed by a new all-time high.
So next time you see a market pullback, remember: smooth sailing all year long is actually the exception, not the rule. And even crashes are an opportunity to set yourself up for long-term wealth creation – depending of course on which political party is setting tax policy. But if you remain disciplined, stick to your long-term plan, and let time do the heavy lifting, you’ll do just fine.
That’s all for today.
Be sure to follow for more smart money breakdowns!
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
