The Permanent Challenge of Temporary Declines
Investment markets were kind to investors in the year 2021. Despite continued uncertainty around how the ongoing pandemic would impact society and the world’s economies, markets worldwide gave investors above-average returns.
More significantly, there were almost no periods of significant declines. To the dismay of the financial media, the S&P 500, the world’s premier stock market index, saw a maximum decline of only 5% throughout the whole year.
Whilst this was a welcome respite from the normal ups and downs of markets, such an unusual run of straight-line market returns could not continue indefinitely.
During 2022, with high inflation becoming entrenched in the developed world, fresh concerns about geopolitical conflict, spiking energy prices and midterm elections in the US, the triggers for the return of market volatility were many.
As a calendar year, for many global stock markets, 2022 was a tough one. ‘One of the worst years on record’ the press gleefully crowed, reveling in their favourite pastime of making a drama out of a crisis. It’s true that many investment markets lost considerable ground in 2022. In the US, the NASDAQ alone retraced by around 25%.
What did that mean to us as investors? Well, our Tatton Tracker client portfolios shed between 6% and 11% - dependent on their risk position. Hardly the financial apocalypse the media would have us believe.
What You Should Know
A market correction is defined as a 10% drawdown from a previous market high. While it may sound like a significant number, these events occur far more frequently than most investors believe. Indeed, they come around as often as your birthday, with years like 2021 – with its consistent gains - being the exception. Over the last few decades, the average short-term decline in a single year is -14%, with about three in four of these years still ending with a positive return overall.
The year 2020 was a good – albeit extreme - example of this. Despite containing the sharpest market crash in living memory which occurred in the first quarter of the year, patient long-term investors who held their nerve (that’s us by the way), still made a positive return over the year.
There will always be some years however in which we make a negative return overall. This happens on average around every five years. This was exactly what we saw in 2022.
Unfortunately, we cannot consistently predict ahead of time when years such as this will occur, or when they will reverse. To be a successful long-term investor is to accept the occasional negative year calmly, confident in the knowledge that it is a temporary set-back as part of a longer journey.
How You Should React
When a threat appears, it’s natural to want to run away. It’s how we’re wired. However, a market decline is not a lion. It’s a (mostly) harmless phenomenon that can only harm you if you react the wrong way.
Market declines will happen consistently over the course of your life, and your mindset when they occur is a choice that will determine your financial future. We recommend that you confront them with confidence rather than fear, mindful of the opportunities they provide.
Importantly, you have the luxury of being a long-term player in a system where everyone’s playing a different game. Contrary to the day-traders, speculators and panicky private investors, what happens in the next 30 days is unimportant to your 10, 20, or 30-year plans. If you’re in it for the long run, the odds are stacked heavily in your favour. You’re virtually guaranteed to win.
We know that stock markets provide positive returns about four in every five years. The negative year is what you must suffer to enjoy the other four. It’s the price of admission for profiting from the collective ingenuity of the hundreds of companies working for you while you sleep. We encourage you to see that the temporary declines are the reason for the stock market’s permanent returns. You can’t have one without the other.
Time Heals
The stock market is a device for transferring money from the impatient to the patient. As you exercise the patience and calm that you’ll need to repeat many times in the future, be encouraged that you are busy earning future returns. If you’re still saving, declines are your best friend, allowing you to buy more units of shares at knockdown prices. If you’re fully invested, then ride out the dip and your diversified portfolio will recover in time.
Success in life requires the practice of rationality during uncertainty, and to be successful long-term investors, we must stick to our long-term financial plan, rather than react to short-term market movements. We are here for you as we continue to work on your plan together. While we don’t know where the market will be in 6 months, we’re pretty confident where it is likely to be in 10 years: much higher.
Patience is the enemy of market declines, and we’ve got plenty of it
