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Investing / April 15, 2020

Why You Should Expect More Market Volatility


The past two months have been tumultuous for investors. As COVID-19 has spread, global markets have been extremely volatile. In mid-February, the S&P 500 was at an all-time high. In the weeks since February 19, we’ve experienced both the index’s fastest decline (33.9% in a little over a month) and its best three-day period since the 1930s. It’s no wonder some investors are feeling uncertain about what the future might hold. Recent sharp rallies (or increases in prices) might lead you to wonder if the S&P 500 is already on its way to recovery. But it’s too soon to say.

We don’t have a crystal ball, and we have no way of predicting whether global markets will fare better or worse in the short term. But we can look at history for context about how markets have behaved in the past. Our educated guess? There’s likely more volatility ahead, but that should have no bearing on your long-term investing strategy.

A historical perspective

History shows that market crashes usually aren’t smooth. Instead, there’s often a bumpy ride to the bottom with lots of false starts. We analyzed S&P 500 declines of more than 30% as far back as the Great Depression to see what has historically happened on the way to the trough. Our analysis shows that the S&P 500 rallied more than 5% an average of 7.7 times before finally bottoming out. The average rally was 12.12%.

Source: Wealthfront

Let’s look more closely at a recent example. Many of us remember the financial crisis that began in late 2007 and bottomed out in March of 2009. What you might not remember is that the S&P 500 rallied many times – increasing by at least 5% on nine occasions – before finally hitting bottom. The average size of those rallies was 10.87%, and the largest was 24.22%. The graph below shows the S&P 500’s decline from late 2007 until early 2009, and as you can see, it was anything but smooth.

Source: Yahoo Finance

So what does that mean for you? In the short term, we encourage you to manage your expectations. The rallies we’ve seen recently aren’t necessarily a sign that the S&P 500 is on the mend just yet. In the long term, however, these bumps mean nothing: markets tend to rise over time and there’s no reason to believe this time will be any different.

Volatility is a feature, not a bug

Short-term volatility isn’t necessarily a bad thing. In fact, it’s a normal part of investing for the long term. A recent New York Times article did a nice job explaining the role volatility plays in the stock market. Neil Irwin wrote: 

“The fact that stocks are extraordinarily volatile right now, in that sense, isn’t a problem with stock investing – it’s a feature! If it weren’t for these periods of fear, stocks would trade at levels that offer returns more like bonds or cash. The fancy academic name for this is the ‘equity risk premium,’ but an ordinary saver can simply think of higher long-term returns as the compensation you get for tolerating volatility.”

It’s normal to find volatility uncomfortable – experiencing loss (even if it’s temporary) is painful. But it’s important to remember that you don’t actually lose any money until you sell your investments for less than you paid for them. If you haven’t sold your investments, you haven’t lost money on them. We encourage you to continue putting money into the market regularly, whether you invest with Wealthfront or someone else. In fact, investing regularly in a volatile market can yield better returns than investing in a steadily rising market. This is why it’s so important to stick to your investing plan regardless of the external environment. 

Many people find themselves in challenging circumstances right now, and we think it’s important to be realistic about what’s to come. In all likelihood, investing will be a bumpy ride for a while – and it’s a good reason not to check your portfolio too often. Instead, you should stay calm and keep investing for the long term. 

Disclosure

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The Wealthfront Team believes everyone deserves access to sophisticated financial advice. View all posts by The Wealthfront Team