SWP Market Insights – Fall 2014
SWP Market Insights – Fall 2014
November 19, 2014
Most people recognize that investing can be risky. While risk comes in many different forms, for many investors the daily swings in the popular stock market indexes are often viewed as the embodiment of risk. Since the stock market bottom of 2009 and until very recently, however, markets have been relatively calm. During this time, stock performance has actually been quite strong, aside for a few small periods of decline. But market conditions have also changed during this time. As stock prices and valuations move higher, there is a possibility of increased swings (up or down) in value. In order for investors to remain poised, it is important to put the recent past in perspective, maintain a long-term view, and stick to a strategic investment plan.
When it comes to monitoring the risk of investing, we feel that it is important to keep things in perspective. While there are different ways to actually look at the risks of investing, we believe one important measure is “drawdown,” which is defined as the amount of decline of an investment from its top to bottom. In 2013, for example, the largest drawdown for stocks was about 6%. Based on historical standards, however, this is quite low. In fact, since 1928, there have only been 7 years with smaller drawdown than 2013. The graph below dates back to 1998, and shows the drawdown in each year compared to each year’s final return.
As the graph above shows, for the last two years, market drawdowns have been small relative to many of the preceding years. Despite there being an intra-year drop in each year (represented by the purple dots), the return for the year ended up being positive in 11 of the 16 years (the gray bars). Furthermore, over this time period, the stock market, as measured by the S&P 500, has enjoyed an average gain of 6% per year. While the fairly modest downside risk may continue, it has been somewhat abnormal, and therefore should be kept in perspective.
An investor’s sensitivity to risk should be partly based on his or her investment time horizon. Rather than becoming fixated on daily fluctuations, most investors should consider longer investment horizons. Over extended periods of time, equity markets have proven to provide good returns for patient investors.
As an example, there has never been a 20-year period since 1950 where stocks have experienced a net loss. Of course, not all investors have this long of a time horizon. But even shorter time periods have generally been positive. In fact, the worst 5-year period for stocks since 1950 was a 2% per year decline, while the best 5-year period was a 28% per year gain. So looking beyond short-term volatility, and considering the longer-term is very important for investors to be able to enjoy the benefits that come with risk.
Sticking to a strategic plan is also important. We agree with most advisors that timing the market is nearly impossible. The table below shows the calendar year returns of stocks and bonds, with the higher-performing asset listed first:
Over this particular 16-year period, stocks did better ten times and bonds six times. Perhaps more striking, there have been dramatic swings in the range of returns, with no particular trends apparent from one year to the next.
But while the returns themselves are so unpredictable, the volatility of each asset’s returns are much more consistent from year to year. As a result, we believe that an important part of constructing portfolios is based on the exposure to volatility. The chart below shows how much more predictable risk has been over time, especially the relative risk between stocks and bonds.
Based on annualized standard deviations, which measure how much returns each year vary from their average, stocks (grey line) are consistently more volatile than bonds (green line). In order to manage the volatility that one has to expect in stocks, other strategies can be introduced. We help our clients build portfolios where volatility might be less, by including not only bonds but also a number of alternative strategies. Maintaining discipline and sticking to a strategic plan, including a well-reasoned approach to the predicted volatility of each asset class, is a sensible approach to investing.
In order to make money in the stock market five years ago, an investor needed to be brave enough to invest. Moving forward, however, an investor may need to be brave enough to remain invested. While volatility in the markets is to be expected, it can be reasonably navigated by keeping an appropriate perspective, a long-term view and a disciplined approach to building a portfolio.
This newsletter contains general information that is not suitable for everyone. The information contained herein should not be constructed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.
Strategic Wealth Partners (“SWP”) is an SEC registered investment advisor with its principal place of business in the State of Illinois. The brochure is limited to the dissemination of general information pertaining to its investment advisory services, views on the market, and investment philosophy. Any subsequent, direct communication by SWP with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of SWP, please contact SWP or refer to the Investment Advisor Public Disclosure website (https://www.adviserinfo.sec.gov).
For additional information about SWP, including fees and services, send for our disclosure brochure as set forth on Form ADV from SWP using the contact information herein. Please read the disclosure brochure carefully before you invest or send money (https://www.stratwealth.com/disclosure-statement).