Welcome to reality.
Stocks’ continual ascent since March 2009 seduced many investors into believing a fantasy: Stocks are low-risk, low-volatility investments. Plunging sell-offs are the province of a distant future.
It was never true, as events of the past week have proven. Plunging market sell-offs will occur, usually when least expected. That’s reality.
The good news is that a proper perspective proves that reality isn’t to be feared.
The Dow’s Plunge Is a Piker
The Dow Jones Industrial Average plunged 1,175 points on Monday. This was the largest single-day drop in Dow history. Many media outlets exploited the fact. The word “historical” peppered the headlines.
Technically, the Dow’s drop was historical. The Dow had never dropped by that large a number. We have more to the story of market sell-offs, though.
The 1,175 points was a numerator that’s meaningless without an accompanying denominator. The denominator was the Dow’s closing price the day before. The denominator was 25,500. The percentage decline attributable to the 1,175 points was 4.6%.
When we focus on the percentage, we find that 4.6% is far from historical. It barely registers as a shrug. A 4.6% decline fails to break into the top-20 percentage declines in Dow history.
Here’s another dose of reality: The Dow declined 12.8% on Oct. 28, 1929. It declined 22.6% on Oct. 19, 1987. The largest recent percentage decline occurred on Dec. 1, 2008, when the Dow declined 7.9%.
Yes, the Dow’s decline was the largest in absolute numbers. It was hardly a plunge; I offer no more than a shrug.
The Bias Is Up
For argument’s sake, let’s say that the market sell-offs snowball into a bear market (which I’m unconvinced it will). What should we expect?
Morningstar data tell us that the average bear market lasts 18 months. It produces an average 40% drop in the S&P 500.
Bear markets can be punishing, to be sure. Forty percent isn’t a trifle.
The S&P 500 dropped 43% during the bearing beginning late 2000 following the bull-market highs set in March 2000. Those highs weren’t seen for another seven years, until 2007.
Another bear market hit in December 2007. The S&P 500 lost 56% of its value by March 2009. The highs seen in late 2007 weren’t seen until March 2013.
But not all bear markets are punishing. A few have been fleeting.
The S&P 500 lost 33.4% in the bear market of late 1987. The bear’s appearance was brief. The S&P was setting new highs less than two years later.
A market correction — a drop of 16.9% — hit the S&P 500 in the summer of 1990. Again, we find a quick turnaround: The S&P 500 was setting new highs six months later. The S&P 500 would quadruple in value over the subsequent decade.
Over the past 100 years, bear markets have averaged 18 months, but bull markets have averaged 97 months. The bias for the stock market is up. A glance at a long-term chart of the S&P 500 will confirm the bias.
Market Sell-Offs: Long-Term Advantage
The initial impulse is to fold ‘em and leave. When stocks start rolling over, investors start placing sell orders.
If you’re an investor — as opposed to a trader — and measure your investing horizon in years, resist the impulse to sell. You will survive the bear market, whether it’s fleeting or punishing.
Wharton School finance professor analyzed stock-market data collected back to 1871. The data show that 9.6% was the median 30-year average annual return over the past 146 years. Similar returns are seen for 20 years. Even the 15-year period is encouraging. No loss has been recorded.
So, if you’re a long-term investor — and an income investor, in particular — it’s best to kick back and wait for the turnaround.
I offer another reason to kick back and wait: You reduce the risk of missing the “big pop” days.
Data compiled and analyzed by Index Fund Advisors show that big gains — the wealth-changing gains — are frequently concentrated in just a few days. If you miss even a couple of the “big pops,” your returns take a pounding.
The table below covers the S&P 500 from Jan. 1, 1994 through Dec. 31, 2012. The hit returns took for missing even a few days was hard indeed.
$10,000 Invested in the S&P 500 Index
|S&P 500 Annualized Return||
Terminal Value of the $10,000
|Impact of Missing Days|
|All 5,037 Trading Days||9.22%||$58,352||$48,352||None|
|Less the 5 Biggest-Gain Days||7.00%||$38,710||$28,710||-40.62%|
|Less the 10 Biggest-Gain Days||5.49%||$29,121||$19,121||-60.45%|
|Less the 20 Biggest-Gain Days||3.02%||$18,146||$8,146||-80.15%|
|Less the 40 Biggest-Gain Days||-1.02%||$8,149||-1,851||-103.83%|
Source: Index Fund Advisors
You might argue that timely selling means missing the worst-performing days. You wouldn’t be wrong, but you might not be right. Good luck with your timely selling. Empirical evidence tilts the odds against you: Your sales will be less timely than you think.
The bias is for the broad-based-market indices to rise over time. My bias is to position myself for long-term success by remaining invested through thick and thin.