Every time Sruly Folger checked the news headlines recently, he heard about the plunging stock market. Share prices were down by over 10% in just three weeks, and it seemed like a big financial meltdown was imminent. Struly had put a large chunk of his savings into a stock mutual fund which had grown beautifully over the past few years. While Sruly was pretty young and hadn’t paid any attention to the major Wall Street crash in 2008, his more experienced investor friends were fearful of a replay of that horrific financial experience. Did this fall in stock prices signal the beginning of a significant market crash? Was it time to bail out and sell all his investments?
What Goes Up Also Comes Down
If your teenage child smiled all day for four weeks straight, you’d probably get a bit concerned. Financial markets, like well-functioning people, have occasional ups and downs, so a dip in the market after a while in which it went straight up is actually a sign that the market is functioning correctly. In fact, the potential for losses is what justifies the impressive gains long-term stock investors have enjoyed for centuries. So, while sudden sharp declines in the stock market make for good headlines, they usually mean a lot less than you would think. Since 1900, the stock market has declined by 5% or more about three times a year and by 10% once a year or so, only to bounce back within a few weeks or months. Since this kind of volatility is usual, a well-diversified investor can (and should) safely ignore the hubbub about these ongoing price fluctuations. Just as your teen being a bit glum is not a big event, neither is the market’s occasional 10% pullback.
The panic over every jitter in the stock market is a relatively new fad. Not very long ago, most investors would get market updates once a quarter, when they received their brokerage statements in the mail. More hands-on traders would subscribe to the Wall Street Journal, which allowed them to check up on their stocks daily. In today’s smartphone era, even supposedly long-term investors can quickly become obsessed, glancing at every instantaneous flicker of the Dow or S&P 500. In turn, for many, stock investing is no longer about sharing in the persistent growth of a solid business but a quick gamble on the current direction of prices. This shallow mindset causes people to lose perspective of whether the market is truly doing well or not.
Just Hold On
If you put your eye too close to anything, it will look humongous and out of proportion. Let’s zoom out a bit to get a more balanced perspective on how the stock market has been doing. Someone who in 2008 invested $10,000 in a diversified stock fund would now have $24,422 (+140% or 9.43% compounded annually). If they’d instead invested the $10,000 in 2013, the pot would be worth $19,158 (+91% or 13.89% annual) and based on a one-year hold, $11,536 (+15%). All of these growth scenarios remain excellent despite the reported 10% fall that Sruly is worried about. In fact, even over a three-month span, returns for the stock market have been pretty good overall: it’s only those who got in during an extreme low that lost money.
Even Through a Big One
Even if reported softening signals the beginning of a prolonged market crash, as long as Sruly is properly diversified and isn’t forced (by financial pressure or panic) to become a seller in the down market, he will be fine. While stocks can lose a tremendous amount of their value in the short run, over time, a diversified portfolio of stocks is a surprisingly solid investment. Even during the Great Depression, the worst collapse in US history, those who were able to hold on through the terrible downturn made very handsome returns. After factoring for dividends and inflation, well-diversified investors in the 1930s regained their losses within about four years even though the market was down by almost 90% at one point! While it was a wild roller coaster ride, the stock market showed excellent long-term profits through even that most difficult period.
Still, if the market may fall further, Sruly is probably wondering if he should get out of the market now, when it looks wobbly, and buy back in after things stabilize. Wouldn’t his returns be much better if he only gets the upward price movements of the market and avoids the scary falls? The answer is, yes, of course, avoiding all the bad and getting all the good would produce phenomenal returns. Unfortunately, even the world’s top investment experts have very limited ability to jump in and out of the market at just the right times. Although the stock market has been very consistent in its excellent long-term prospects, anything can happen in the short run. Therefore, by trying to avoid the ongoing fluctuations, it’s probable that Sruly will forgo most of the market’s rewards as well.
Stocks Are Not for the Fainthearted
The highlight of many amusement parks such as Six Flags Great Adventures are the massive roller coasters with their intense speeds and crazy twists. While many people find these coasters thrilling, they can be unpleasant or even unsafe for others. Every amusement ride features signs announcing restrictions based on height, medical condition, and/or tolerance for being flipped and zipped in all different ways. When someone ignores the warnings and has a bad time riding, it makes no sense for them to blame the roller coaster. So too, every investment comes with the warning that there is a tendency for sudden drastic collapses in price. If Sruly can’t handle these financial drops and loops, he’s on the wrong ride!