There has been a lot of discussion about the stock market’s losses over the last week, the rise in interest rates, climbing inflation, and of course the “sharp” increase in volatility. We wanted to put these items into historical context. The charts below begin on January 19, 1993. We chose this day because it’s the day the Chicago Board Option Exchange introduced the VIX (the Volatility Index). We have broken down the various data points into multiple charts to make it easier to read. And after acknowledging that no one wants to see a week in the market like what we’ve seen since the beginning of February (the S&P500 having lost 8.5% in the last 8 days), we would like to redirect our attention to the bigger picture.
Since the market’s inception, it has consistently had drops like what we’ve just experienced, and the last 25 years have been no exception. In the chart below (spanning the last 25 years) we’ve marked drops in the market that look similar to what we’ve just experienced. The big picture is that despite the pullbacks, the market has produced an annualized rate of return of 9.4%.
We frequently say it is more important to manage your “Time in the Market” than it is to manage “Timing the Market.” The next chart illustrates this. If one had made the now seemingly appropriate decision to get out of the market on January 31, 2018 before this pullback, it would have only changed the annualized return by 0.4% per year. We don’t want to discredit the impact of earning an additional 0.4% per year, because over 25 it can add up, but rather we wish to highlight the importance of proper financial and retirement planning. If your required rate of return, as identified through your financial plan, requires your portfolio to earn a return of 4%, or 5% or 7%, these seemingly significant market draw downs become insignificant.
Dalbar, one of the financial community’s leading independent experts for evaluating, auditing, and rating investor performance has been producing research since 1994 to better understand the impact of investors’ attempts to “Time the Market.” Their research has consistently shown the average annualized performance of the “average equity mutual fund investor” does not keep up with the market. Their findings in their report released in 2016 found that while the S&P 500 had produced an annual return of 10.35% over the last 30 years, the average equity mutual fund investor only earned a return of 3.66%. The average equity mutual fund investor even underperformed the Barclays Aggregate Bond Index, which produced an annualized return of 6.73%. Many investors at first blush may be inclined to attribute this to the funds’ fees and expenses, but Dalbar’s research showed that, “No matter what the state of the mutual fund industry, boom or bust: Investment results are more dependent on investor behavior than on fund performance. Mutual fund investors who hold on to their investments have been more successful than those who try to time the market.” What may be more surprising to many, is that they also found that investors guessed right about the direction of the market 75% of the time, and yet they still dramatically under performed the market.
Returning back to the importance of a financial plan (and following it), the market’s ups and downs over long periods of time have had relatively low impact on investors’ overall performance, but investors’ attempts to time the market have had a significantly detrimental impact on their overall performance. If an investor’s required rate of return were 4%, or 5%, or 7%, and their attempt to time the market reduced their annualized return to 3.66%, then their attempts to reduce their risk and limit their losses would have actually caused them to fail to meet their required return.
With respect to interest rates, we believe the chart of the last 25 years shown below illustrates that the climb in rates we’ve just experienced may not be as large a concern, nor as unique an event as the media portrays. We’ve marked rate increases in the 10-year rate in the chart below with red arrows. The percentage increase is so large because the overall rate is so LOW. To borrow a word from the Federal Reserve, the current rate is still incredibly “accomodative” and very near both cycle and all-time lows.
On the topic of inflation, there’s not much to say, but we believe the chart of the last 25 years of inflation says it all. The Fed has done a pretty good job at maintaining steady and stable inflation, and we have no reason to believe they are going to fail now.
Last, but certainly not least, we wanted to touch on the Volatility Index. We’ve marked some of the larger increases in volatility with red arrows and circled the current level in red at the far right of the chart, as it’s a little hard to identify. The current behavior of the volatility index is normal, and this is the fourth such climb since the beginning of recovery in 2009. We do not believe this is any more cause for alarm than the spikes in volatility experienced in 2010, 2011, or 2015 were.
If you have any questions, please call or email us.
Sincerely
Fortem Financial
