Have a Plan and Stay the Course When Markets Turn Turbulent
Following months of volatility in a challenging start to the year for the U.S. stock market, the S&P 500® Index closed in bear market territory in mid-June for the first time in two years. A bear market is commonly defined as a 20% decline from a previous high. Volatility is likely to continue amid a host of uncertainties that include elevated inflation, Fed rate hikes, continued supply chain bottlenecks, slowing economic growth and the Russia-Ukraine war.
Other U.S. stock market segments entered bear markets months ago. The Nasdaq Composite Index, which includes many of the high-flying consumer technology stocks that have tumbled in recent months, and the Russell 2000® Index, which measures the U.S. small cap stocks, were each down about 30% from their November 2021 highs as of mid-June.
The volatility has extended to bonds as well, which have declined along with stocks at times due to the pressure from rising interest rates. This has presented a particular challenge as investors in conservative portfolios that emphasize bonds have had to weather sizable portfolio declines along with investors in more aggressive portfolios that emphasize stocks. The high correlation between stocks and core bonds such as Treasuries has also highlighted the importance of investing in other defensive asset classes such as cash and gold as well as diversifiers within equities such as fundamental indexing.
With the abundance of uncertainties, investors are struggling to assess whether the market sell-off might be near its crescendo if inflation begins to moderate and economic growth remains solid or whether the turbulence might be the beginning of a more protracted downturn and sign of a potential recession.
Either way, it's important to recognize that volatility is a normal part of investing and potential long-term success requires withstanding these inevitable periods of turbulence. This is why having a long-term plan is so critical. So that when a correction or bear market does occur, you're prepared and can avoid falling into the trap of letting emotion drive decision-making.
Keep a steady hand on the tiller to help navigate market pullbacks
Schwab Intelligent Portfolios® has successfully navigated five market corrections (commonly defined as a pullback of at least 10%) since its March 2015 launch and one short-lived bear market (a pullback of at least 20%) in Q1 2020.
Only time will tell how long the current market turbulence will last, but there are a few important points to keep in mind to help you stay focused on your longer-term plan:
- Bear markets have historically been far shorter than bull markets. Since 1966, the average bear market has lasted approximately 15 months and resulted in a 38% decline, according to the Schwab Center for Financial Research. By contrast, the average bull market has lasted nearly six years, with a gain of approximately 210%. The last bull market brought gains of more than 400% over 11 years, while the current bull market saw an advance of more than 120% in less than two years following the shortest bear market (one month) in recorded history and was still up 80% from the March 2020 low despite the pullback in 2022.
- Diversification is designed to help moderate declines. Investing in a diversified portfolio that includes a mix of stocks, bonds, commodities and cash based on your goal, time horizon and risk profile can help moderate overall portfolio volatility. Figure 1 shows how a hypothetical moderate risk portfolio of 60% stocks and 40% bonds would have seen a significantly smaller decline than the U.S. stock market during the 2008 – 2009 financial crisis. And Schwab Intelligent Portfolios includes defensive asset classes such as Treasuries, gold and cash specifically for these periods of volatility. Those investments might not seem important when stocks are going up, but they sure prove their value when stocks are falling.
Figure 1: Diversification is designed to help moderate declines
Source: Morningstar Direct. The moderate risk portfolio consists of 60% S&P 500 Index and 40% Bloomberg Barclays Aggregate Bond Index and was rebalanced semi-annually.
- Staying the course can help shorten your recovery period. While seeing your portfolio decline never feels good, investing in a diversified portfolio and sticking with your targeted allocation can help speed recovery. Figure 2 shows how the hypothetical moderate risk portfolio would have recovered to break even in less than half the time the U.S. stock market took to reach its previous high. Moderating portfolio declines means you have less ground that you have to make up when markets recover.
Figure 2: Diversification can help shorten recovery periods
Source: Morningstar Direct. The moderate risk portfolio consists of 60% S&P 500 Index and 40% Bloomberg Barclays Aggregate Bond Index and was rebalanced semi-annually. The 60/40 portfolio recovered from the March 2009 low to reach its previous peak in November 2010, while the S&P 500 did not reach its previous peak until March 2013.
- Market timers risk missing the rebound. Selling in a panic amid a market decline typically means locking in short-term losses and getting off track from your longer-term plan. Staying the course and rebalancing to keep your targeted allocation consistent is generally a wiser strategy. The biggest gains often come in the early stages of a recovery, and missing even just the first month of gains can have a big effect on future performance. As shown in Figure 3, missing just the top 10 days in the market over the past 20 years would have cut annualized returns by nearly half, according to the Schwab Center for Financial Research.
Figure 3: Time in the market is more important than timing the market
Index annualized total return (2002-2021)
Source: Schwab Center for Financial Research with data provided by Standard & Poor's. Return data is annualized based on an average of 252 trading days within a calendar year. The year begins on the first trading day in January and ends on the last trading day of December, and daily total returns were used. Returns assume reinvestment of dividends. When out of the market, cash is not invested. Market returns are represented by the S&P 500® Index. Top days are defined as the best-performing days of the S&P 500 during the 20-year period. Indexes are unmanaged, do not incur fees or expenses, and cannot be invested in directly. Past performance is no guarantee of future results.
Having a longer-term plan and sticking to it is key to investment success
We know that markets can be volatile in the short term. But we also understand that having a long-term strategic asset allocation plan and sticking to that plan through periods of market volatility are among the keys to long-term investment success.
Schwab Intelligent Portfolios is designed to provide broad diversification across up to 20 asset classes in any portfolio, including defensive asset classes such as cash and gold that can help you withstand these inevitable periods of volatility. This broad diversification along with an automated rebalancing process can help provide the discipline to remain calm during short-term volatility while staying focused on longer-term objectives.
By David Koenig, CFA®, FRM®, Chief Investment Strategist, Schwab Intelligent Portfolios