By Steve Tepper, CFP®, MBA
Between February 21 and March 21, 2020, the S&P 500 tumbled 35%. Since then, major indices have been bouncing around like pachinko balls. What will happen next?
Not surprisingly to our regular readers, my answer is “I don’t know.”
While we’ve never seen stock prices tumble so far so quickly from record highs, we have certainly had market setbacks, and we have vast amounts of data that tell us what happened afterward. We know that past trends do not guarantee what will happen in the future. Nothing can. But past market behavior could give us some idea of what might happen, and even if we have to move forward in uncertainty, we don’t have to fly blind.
Looking at the table, going back to 1926, total U.S. stock returns in the year following a 10% decline averaged 11.03%. The average annual returns over the three and five years following a 10% drop were also between 11% and 12%.
After a 20% market decline, the one-year numbers are even better, averaging 14.21%!
Market downturns are always to be expected. We don’t know when or how far markets will fall, but history tells us the bounce back is often quick and robust. “Blink and you missed it” kind of stuff.
This is what makes market timing so challenging: You have two variables, and they are both working against you.
First, your signal to get out will often come after a good amount of the decline has already occurred. Think about it. When did people start talking about getting out of the stock market? It wasn’t February 21. It was well into March. Markets were already at “bear” territory, down 20%.
Your second challenge is that your re-entry cue may come after the recovery is well underway. That’s what the data in the chart is telling us. Do you want to wait a year and risk missing 11% or 14% of the market bounce?
These two market timing challenges could easily leave you with an exit point lower than your point of reinvestment. “Sell low, buy high” is not an effective investment strategy. “Faith, patience, discipline” is.
Keep faith that capital markets will continue to reward investors in the long run, patience to wait for the reward you deserve for the risk you take, and discipline to stick to a solid, proven investment strategy.
Adapted from information provided by Dimensional Fund Advisors.
Past performance is no guarantee of future results. Short term performance results should be considered in connection with longer term performance results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Periods in which cumulative return from peak is –10%, –15%, or –20% or lower and a recovery of 10%, 15%, or 20%, respectively, from trough has not yet occurred are considered downturns. Returns are calculated for the 1-, 3-, and 5-year look ahead periods beginning the day after each downturn. Whether a period is considered a downturn is analyzed on a daily basis, and therefore the 1-, 3-, and 5-year look ahead periods are overlapping. The bar chart shows the average returns for the 1-, 3-, and 5-year periods following 10%, 15% and 20% downturns. For the 10% threshold, there are 3,442 observations for 1-year look ahead, 3,396 observations for 3-year look ahead, and 3,345 observations for 5-year look ahead. For the 15% threshold, there are 3,175 observations for 1-year look ahead, 3,167 observations for 3-year look ahead, and 3,166 observations for 5-year look ahead. For the 20% threshold, there are 2,561 observations for 1-year look ahead, 2,560 observations for 3-year look ahead, and 2,560 observations for 5-year look ahead. Peaks and troughs are patterns that are developed by the price action experienced by all securities. Peak is the highest point prior to a drawdown, and trough is the lowest point after the peak. Data provided by Fama/French. add back in available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.