Market will fluctuate

This is an actual quote from nearly a century ago by American financier J.P. Morgan when asked about market direction, and it is at the level of other two life certainties, death and taxes.  Looking at recent market movement, it definitely fluctuates.  This week capped the best 3-day comeback in years, after investors apparently decided that low oil prices are, in fact, pretty good for the economy.  Back in October, the market came very close to an official correction due to Ebola fears and other factors, which, in all truthfulness, I no longer remember.

Over the long term, stocks outperform other liquid investments, such as bonds and treasury bills, and rise, on average, about 10% per year.  But that rise does not follow a straight line — market, well, fluctuates.  These fluctuations can be quite extreme in either direction, but tend to be sharper going down.  A decline from 10% to 20% from a peak is called a correction.  Corrections are very common and occur, on average, every 18 months or so.  A bear market is a decline of 20% or more.  An average bear market results in a loss of 30% and lasts 9 to 18 months (sometimes longer).

During the last 100 years, we witnessed 18 bear markets, which included 9 protracted bear markets with declines of more than 30%.  Two of these severe bear markets happened this century, in 2000-2002 and again in 2007-2009.  In fact, corrections and bear markets are recurring and expected events.  While it is undeniably hard not to get emotional during market declines, in rational terms, worrying about that is just about as productive as worrying about rainy weather.  You don’t assume that several days of rain signify the beginning of the next Great Flood.  Yet, if you listen to financial media during these times, you would be convinced that not only the Great Flood is upon us, but that the Ark has already sailed.

The 19th bear market will happen.  That’s as certain as that J.P. Morgan quote.  Maybe it will start tomorrow, next month, next year, or 5 years from now.  The pullbacks are a natural part of the market life cycle.  A savvy investor should not fear or get upset with such corrections, but be prepared for take advantage of the low prices and a coming upswing in the market.

Invest for the Long Term

With major market indices keeping hitting new highs seemingly every day, what should investors do?  While no one knows what will happen tomorrow, next month, or next year, I do know that investing for the long term works.  In fact, I will say that over the long term, staying out of stock market is more risky than being fully invested.

While that statement may leave you scratching your head, consider that since 1900, the stock market returned about 10% annually on average, while the nearest competition, bonds, returned only 4%.  The difference is huge: $1000 invested at 10% will grow to $17,449 in 30 years, while that same $1000 will reach only $3,243 at 4%.

The domination of the stock market has been quite consistent over short intervals as well.  According to Stocks for the Long Run by Jeremy Siegel, over 5 year periods stocks outperformed other investment vehicles 70% of the time. Over 10 years, 80% of the time.  And over 30 year periods, stocks always outperformed other investment types.

This outperformance does come with a price of short-term volatility.  However, as history shows, over long term, stocks are in fact less risky, if you define risk as opportunity cost.  In my view, investing in “safe” securities and realizing subpar returns is far greater risk than the risk of short-term fluctuations in the stock market.