by Patrick Nolan, CFA, Blackrock
Corrections are normal but that doesn't mean they feel good. How to get comfortable with being uncomfortable.
We get it. This is uncomfortable. The wild gyrations of the markets over the last few weeks has reminded some of the great financial crisis of 2008. Three months ago, most didn’t know what a coronavirus was. Now it’s impacting our daily lives.
THIS is what risk feels like.
Unexpected stuff happens, which is why being prepared is so important. It’s why we preach diversification and suggest building portfolios that include seemingly boring investments that don’t go anywhere, making us wonder why we own them. Now we know why.
Perspective is also crucial in times like these. History is not only a good reminder of the inevitable ups and downs of the market; it can also furnish lessons for what to do (and not do) when the inevitable happens again. Here are three to think about now.
Lesson One: Stay calm
It’s important to put the current markets in context. The S&P 500 Index ended 2019 up 451% from its bottom in March of 2009. That represents an average annual return of 17.1% over the decade. The S&P 500 is now giving back some of that gain. It feels scary, but it hasn’t taken away most of the gains we’ve enjoyed over the past eleven years. That said, don’t be complacent. Things can get worse before they get better.
Lesson Two: Stay invested
The terrific returns of the past eleven years have also come with very little volatility. The correction (an index down 10% from its peak) we officially reached two weeks ago was only the 6th such episode over the past eleven years. Prior to the current decline, the worst of the bunch (down ~20%) occurred at the end of 2018. The second worst (down 19%) occurred in 2011. In both cases, the market recovered and made new highs within five months. The other three corrections barely made it to 10%-down levels and recovered even faster than that. Corrections normally happen more frequently than we’ve seen in the past decade. When you’ve become comfortable watching your investments consistently go up, it can be quite jarring to watch them fall out of bed. But it shouldn’t chase you away from the stock market, especially if you have a long horizon.
Lesson Three: Stay diversified
We’ve been here before. The decade of the nineties, fueled by the launch of the internet, produced a technology-driven bull market that drove the S&P 500 up over 17% per year for almost a decade. Volatility was down, drawdowns were scarce and investor complacency was high. Sound familiar? At the time, some investors felt that owning bonds and other less risky investments wasn’t useful, choosing instead to simply own more technology stocks. What followed was a recession that kicked off a 30-month-long downward trending stock market that gave up 44% of its value from peak to trough. An estimated $5 trillion of market value was lost in technology companies alone during this time. It reinforced a timeless lesson that diversifiers usually work, and we must continue to own them, even if they don’t make us feel good while the market is going higher. The same lesson was taught to us again in 2008-2009.
We’re not predicting the next recession. But it’s an important reminder to keep our return expectations under control, and that we can’t simply own just the things that make us feel good. There should always be investments in the portfolio that make us uncomfortable. They are there to help in case the markets don’t go the way we expect. At those moments, like now, our least comfortable investments may be what ultimately helps preserve the portfolio’s value: losing less now means we can recover more quickly when markets turn around.
Risk is supposed to make us uncomfortable, but it’s also where returns come from. When it works against our investments, it can be abrupt and scary. True wealth is built by being disciplined with our investments.
Investors who stay calm, stay invested and stay diversified will be the ones who best weather the storms and reap the rewards when the clouds dissipate and the sun re-emerges.
Learn more about ways to manage risk.
Investing involves risk, including possible loss of principal.
Index performance is shown for illustrative purposes only. You cannot invest directly in an index.
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This post was first published at the official blog of Blackrock.