Boaters prepare and practice for emergencies. The Boy Scouts motto is: be prepared.
As investors, we all need to be prepared.
As we discussed last week, the long-term average annual return of US large company stocks is 10%
However, each year’s return generally varies from this 10% average. One year may be up, the next may be down. There are years of small gains and others with large losses. Stocks can go down for month after painful month, with seemingly no end in sight.
This is the inherent risk in owning stocks. This is the fear factor. The reality is that broad stock markets can lose 20%-30%-40% or more in a year or two. Individual stock losses can be even worse.
Let’s focus on two key points:
- Temporary losses (declines)
- Declines will occur at various times.
To be a successful long term investor, you need to be prepared for the extent of the declines which will likely occur in the future, just as they have in the past. The timing of the declines are not predictable, just as it is not possible to accurately predict when the gains will occur.
The declines will only be temporary, even though it does not feel this way in the midst of a significant market downturn…unless you panic and sell all of your stocks and go to cash.
Despite periods of temporary losses, the long-term trend of broad stock market averages is clearly positive. To get to that 10% average annual return I cited earlier, the down years are included.
Historically, there are far more positive years than down years. This is why it is rewarding to remain invested in stocks.
However, at some point during most years, there are intra-year declines of (10-14%), on average. This happens even in years which turn out to be very good ones. For example, last year was a good year for stocks and there were two periods of significant declines. You need to be prepared to handle these types of declines every year.
But wait. There’s more. And it’s worse. On average, there have been major declines of greater than 20% every 5-6 years since World War II.
So why are we reminding you of this vital historical information?
We are providing you with this information so you will be better able to handle the future temporary declines when they occur, as they can’t be predicted. But we know they will occur. We know there will be some kind of crisis. It may be caused by a political or economic event. It may be a “correction,” which is just a natural decline in stocks, on the stock markets’ long-term climb to higher and higher new highs.
We want you to be emotionally prepared for these temporary declines, so you can follow our advice and remain invested according to your investment plan. Remember, US stock markets, as well as International and emerging country stock markets, are made up of individual companies. These companies have real worth, assets, earnings and the ability to adapt.
When the markets declined in 2007-2009, some companies did go out of business. But in a broadly-based globally diversified portfolio such as we recommend, the broad decline was temporary. The vast majority of public companies and their stocks recovered and rebounded to much higher levels than before the crisis. The rebound began much before most people were confident in the economic recovery.
When the next downturn or crisis occurs, we must remember these lessons and facts.
And when the downturns do occur, and they will, we will be here to discuss and reinforce these concepts. We will provide you with the confidence to stay invested. That is exactly what we did for our clients during 2007-2009.
This is our role. This is our value. We are here to be truthful and realistic with you. We want you to be prepared.
We hope this is truly helpful to you and your family, today and in the future.