Is Stock Market Volatility a Bad Thing or a Good Thing?
Spoiler alert – it’s a good thing. There, I just saved you a few minutes of reading. : )
For the A students, let me elaborate. Volatility is one of the key drivers of the historical higher returns of stocks. People have to be rewarded for the bumpier ride that stocks usually take over say bonds or savings vehicles from the bank, like Certificates of Deposit (CD’s). If it was always a smooth ride then there would be no need for the reward – historically higher returns – in stocks. Everybody would want them if it was just a smooth ride up…but since it’s not a smooth ride the returns have historically been a lot higher than bonds and CD’s to reward investors for the volatility they had to endure.
Key point: volatility is in no way synonymous with risk. Risk is when you could lose all your money, volatility is just the short-term fluctuations of an assets price. You may be mistaking normal equity volatility for loss, which it isn’t, unless you sell in fear during a down market. Obviously, one must consider their risk tolerance, and ability to handle these types of fluctuations in their investments.
Let’s look at history to show this – I will reference the S&P 500 index as my proxy for “the market”.
There have been thirteen bear markets with an average decline of 30% since the end of World War II. The first one started on May 29, 1946. That day, the S&P Index closed at 19.5. Today, thirteen “ends-of-the-world” or bear markets later, the index value is 2813 – the day of my writing this. Stocks are up nearly 144 times over those seven decades and guess what? Earnings are up nearly 144 times over that same time frame.
(To see a Fact Sheet on the S&P 500 index, put out by Standard and Poor’s, follow this link: http://www.spindices.com/indices/equity/sp-500 )
That’s a heck of a lot of volatility to endure since 1946. Yet, if someone just left their money alone in an S&P 500 index fund their portfolio would be up nearly 144 times (gross of any fees and expenses) So it’s not the volatility that creates a loss for investors, as just illustrated by their investment being up nearly 144 times, it’s their own behavior. Selling is how a real loss is created, not riding out the volatility.
One more historical point. The average intra-year decline since 1946 has been 13.8%. There has been a 15%-20% decline on an average of one year in three. The last one occurred in 2011 and was 19.2%.
Takeaway, markets are cyclical. And those of us that BUY during corrections vs. sell, generally speaking, reap the rewards of volatility. Because without that volatility, the returns wouldn’t have been as great.
So that is why volatility is a good thing and should be embraced if you are investing for the long term. After all, it is one of the reasons for the historically higher returns.
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