Have a Plan and Stay the Course When Markets Turn Turbulent
The U.S. stock market celebrated the 11th anniversary of the bull market on March 9 with its largest single-day decline since the 2008-2009 Financial Crisis. That plunge came after two weeks of turbulence and was followed by additional declines that brought major U.S. stock indexes down more than 20% from their mid-February highs by the end of the week, marking the beginning of the first bear market in more than a decade.
With fear over the spreading coronavirus (COVID-19), an oil price collapse and growing concerns about a potential global recession driving markets lower, anxiety has inevitably spiked. Investors are struggling to assess whether this might be another short-lived decline followed by a quick bounce such as occurred at the end of 2018 and beginning of 2019 or whether it might be the beginning of a more protracted downturn.
Global central banks have cut interest rates and taken other action to stimulate the economy, but only time will tell whether the global economy will strengthen in the second half of 2020 as had been expected. Either way, it's important to recognize that volatility is a normal part of investing and long-term investment success requires withstanding these inevitable periods of turbulence. This is why having a long-term plan is so critical. So that when a correction or bear market does occur, you’re prepared and can avoid falling into the trap of letting emotion drive decision-making.
Keep a steady hand on the tiller to help navigate market pullbacks
Schwab Intelligent Portfolios® has successfully navigated five market corrections since its March 2015 launch. And while a bear market would be the first in more than a decade, there are a few important points to keep in mind to help you stay focused on your longer-term plan:
- Bear markets have historically been far shorter than bull markets. Since 1966, the average bear market has lasted approximately 17 months and resulted in a 39% decline, according to the Schwab Center for Financial Research. By contrast, the average bull market has lasted more than six years, with a gain of approximately 220%. The latest bull market brought gains of more than 400% over 11 years.
- Diversification is designed to help moderate declines. Investing in a diversified portfolio that includes a mix of stocks, bonds, commodities and cash based on your goal, time horizon and risk profile can help moderate overall portfolio volatility. Figure 1 shows how a hypothetical moderate risk portfolio of 60% stocks and 40% bonds would have seen a significantly smaller decline than the U.S. stock market during the 2008 – 2009 financial crisis. In the most recent period of turbulence, your portfolio has likely seen a smaller decline than the 25% pullback as of March 11 for the U.S. stock market. And Schwab Intelligent Portfolios includes defensive asset classes such as Treasuries, gold and cash specifically for these periods of volatility. Those investments might not seem important when stocks are going up, but they sure prove their value when stocks are falling.
Figure 1: Diversification is designed to help moderate declines
Source: Morningstar Direct. The moderate risk portfolio consists of 60% S&P 500 Index and 40% Bloomberg Barclays Aggregate Bond Index and was rebalanced semi-annually.
- Staying the course can help shorten your recovery period. While seeing your portfolio decline never feels good, investing in a diversified portfolio and sticking with your targeted allocation can help speed recovery. Figure 2 shows how the hypothetical moderate risk portfolio would have recovered to break even in less than half the time the U.S. stock market took to reach its previous high. Moderating portfolio declines means you have less ground that you have to make up when markets recover.
Figure 2: Diversification can help shorten recovery periods
Source: Morningstar Direct. The moderate risk portfolio consists of 60% S&P 500 Index and 40% Bloomberg Barclays Aggregate Bond Index and was rebalanced semi-annually. The 60/40 portfolio recovered from the March 2009 low to reach its previous peak in November 2010, while the S&P 500 did not reach its previous peak until March 2013.
- Market timers risk missing the rebound. Selling in a panic amid a market decline typically means locking in short-term losses and getting off track from your longer-term plan. Staying the course and rebalancing to keep your targeted allocation consistent is generally a wiser strategy. The biggest gains often come in the early stages of a recovery, and missing even just the first month of gains can have a big effect on future performance. As shown in Figure 3, missing just the top 10 days in the market over the past 20 years would have cut annualized returns by more than half, according to the Schwab Center for Financial Research.
Figure 3: It’s difficult to time a perfect re-entry into the market
Source: Schwab Center for Financial Research with data provided by Standard & Poor's. Return data is annualized based on an average of 252 trading days within a calendar year. The year begins on the first trading day in January and ends on the last trading day of December, and daily total returns were used. Returns assume reinvestment of dividends. When out of the market, cash is not invested. Market returns are represented by the S&P 500® Index. Top days are defined as the best-performing days of the S&P 500 during the 20-year period. Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Past performance is no guarantee of future results.
Having a longer-term plan and sticking to it is key to investment success
We know that markets can be volatile in the short term. But we also understand that having a long-term strategic asset allocation plan and sticking to that plan through periods of market volatility are among the keys to long-term investment success.
Schwab Intelligent Portfolios® is designed to provide broad diversification across up to 20 asset classes in any portfolio, including defensive asset classes such as cash and gold that can help you withstand these inevitable periods of volatility. This broad diversification along with an automated rebalancing process can help provide the discipline to remain calm during short-term volatility while staying focused on longer-term objectives.
By David Koenig, CFA®, FRM®, Chief Investment Strategist, Schwab Intelligent Portfolios