While investing in stock markets is typically a sensible choice for investors seeking long-term growth, sharp drops can still be hard to stomach. Our research suggests investors are better off sticking with their long-term strategy when markets tumble, rather than making any kneejerk decisions.
For guidance, if market turbulence makes you feel the need to ‘do something’, consider some of the following charts.
Investors, typically, can endure many so called ‘bear markets’ – market declines of 20% or more lasting at least two months –– during their lifetimes. Using an index as a proxy for global stock markets, the first chart below shows just how many of these there had been since 1980 by the end of last year.
Downturns aren’t rare events
Source: Vanguard analysis as at 31 December 2021, based on the MSCI World Index from 1 January 1980 until 31 December 1987, and the MSCI AC World Index thereafter. Notes: Both indices are denominated in GBP.
In all there were five bear markets and 16 corrections of 10% or more over the period covered. What’s more, there has been one more correction so far in 2022. But despite these downturns, global stock prices continued to new heights, showing the value of staying invested even during periods of sub-par performance.
Dramatic market losses can sting but it’s important to keep a long-term perspective and stay invested to benefit from the recoveries that can follow. Some bear markets since 1980 have been sharp, but many bull-market surges – market rallies of 20% or more lasting at least two months – have been even more dramatic. They have often also lasted longer, leaving stock market investors well compensated over the long term for the risk they took on.
That’s one reason for sticking to a well-thought-out investment plan. Losses from a bear market have typically given way to longer and stronger gains.
Timing the market is futile
The best and worst trading days often happen close together and occur irrespective of the overall market performance for the year. That’s why we think investors shouldn’t try to time the market because they run the risk of missing out on some of the best-performing trading days.
As the next chart shows, the best and worst trading days often occur within days of each other. For example, five of the best trading days of the last 40 years or so, as measured by the performance of the FTSE All Share Index, occurred either in the wake of the global financial crisis in 2008 or after the Covid-19 sell-off in 2020, during years of negative total returns.
The 20 best and worst trading days
Source: Vanguard calculations, based on data from Refinitiv using the FTSE All Share Index. Data between 1 January 1985 and 19 January 2022.
Diversification can smooth the ride
Finally, as the random pattern of returns below highlights, predicting which segments of the market will do well is a tall order.
This chart shows the relative annual performance of different market sectors from 2012 until the end of 2021. As you can see, the relative performance of different investments varies widely from year to year, with leaders and laggards changing frequently.
It’s why broad diversification keeps you from having too much exposure to the worst-performing areas of the market in the event of a downturn.
Performance among asset classes can vary
Source: Vanguard calculations as at 31 December 2021, using data from Barclays Capital and Thompson Reuters Datastream and FactSet. Global shares represented by the FTSE All World Index, North American shares by the FTSE World North America Index, emerging market shares by the FTSE All-World Emerging Index, developed Asia shares by the FTSE All World Developed Asia Pacific Index, European shares by the FTSE All World Europe ex-UK Index, UK shares by the FTSE All Share Index, UK government bonds by the Bloomberg Sterling Gilt Index, UK index-linked gilts by the Bloomberg UK Govt Inflation-Linked UK Index, UK investment grade corporate bonds by the Bloomberg Sterling Aggregate Non-Gilts – Corporate Index, hedged global bonds as Bloomberg Global Aggregate Index (hedged in GBP). Performance shown is cumulative and denominated in GBP. It includes the reinvestment of all dividends and any capital gains distributions.
What you can do when volatility hits:
There’s an old adage about never checking your account when shares are tanking. It’s smart advice. As the graphics above show, making a hasty decision usually results in a mistake.
Revisit your asset allocation. If market losses are making you lose sleep, it may be time to re-evaluate your risk tolerance.
Control what you can. Costs erode your returns. This is particularly painful when stock markets are correcting. So keep your investment costs low.
Set realistic expectations. Vanguard anticipates higher market risks and lower returns over the near term and next 10 years than we did a year ago.
Stay diversified. A great way to insulate your portfolio is to be invested across a wide range of shares bonds and international markets as part of an asset allocation plan that makes sense for your risk tolerance and goals. Bonds can act as a ballast during downturns. International exposure can give you access to markets that may generate positive performance when others are falling.
Following these simple steps can help you avoid overreacting to short-term downturns and position you for long-term success.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
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