Given recent events, I thought it would be appropriate to discuss the volatility – the ups and downs of your portfolio that comes with your investing journey. The basic principal to remember is that we derive above GIC-rates of return by assuming some degree of volatility. And, we all require above GIC-rates of return if we desire to see our savings keep up with the eroding effects of inflation.
Let me share 3 realities of volatility.
Reality #1: Volatility is normal and to be expected.
The first observation, or reality, is that volatility is normal and to be expected. We rarely know what the cause of it will be, but we know it is lurking around the corner. We also know from experience, and observation, that positive upswings in general follow negative drawdowns. From the chart below, we can see the largest drawdown from peak to trough, during a calendar year basis for the last 20 years – highlighted in gold squares. For instance, in 2017 the S&P500 went down by 10%. The equity market tends to dip at some point by at least 10% in 70% of years.
Now have a look at the blue bars. They show the end of year return. We find that in 70% of years the stock market finishes in positive territory. Again, markets will dip by 10% in 70% of years but will end positively in 70% of cases.
Reality #2: A diversified portfolio will recover in time.
There are times where a decline is atypical and severe. It may take years, but history informs us that with patience comes prosperity. The attached chart shows how a balanced portfolio faired after 1-month, 6-months, 1-year, 3-years and 5-year for 5 unique shocks: Black Monday in 1987, the bailout of LTCM, the Dot-com Bubble, 9/11 and the Lehman Brothers Collapse.
Reality #3: Investors will inherently do what feels right which hurts them in the end.
The third observation is that investors typically do the wrong thing. People sell low and buy high. The chart below shows investment flows into equities or stocks alongside the S&P/TSX’s performance. When the lines are below zero investors are selling and when the lines are above zero people are buying. As highlighted by the red boxes, we see that investors tend to sell once the market has declined and get back in only once it has risen. The strategy of getting back in when things look better doesn’t work.
My role is to help find a portfolio mix that delivers the rate of return that makes your financial plan come to life while allowing you to sleep at night. And, let’s be honest sleeping at night can mean tossing and turning at times.
Volatility – let’s be honest the ‘downs’ are not desirable, but they do pass, and we will move forward.
