I am going to start with a trick question:
What is the biggest danger to your long-term investment results?
If you answered with something like “market downturns” or “downside volatility,” you’re not only missing a bigger danger, you may be missing the way investment markets work.
As you can see from the chart below, there have been a lot of market setbacks since 1896, and yet the overall trajectory of the market (as you undoubtedly already knew) has been a fairly steady rise. I realize the print is very small here, but the chart below lists just about every bad event that has happened to the markets and our economy since 1896.
The longest recovery times in modern history have been the 25 years during the Great Depression and the 16 years during the stagflation period of the 1970s. They are also the only times when someone with a time horizon of more than 10 years would have seen a loss after staying invested for a full decade. The recovery time from the severe downturn during the Great Recession was just six years.
Also keep in mind that this chart is a logarithmic trajectory, meaning that the jump from a Dow of 10,000 to 20,000 is roughly the same as the jump from 30 to 50. If we showed it on a standard scale, the paper would need to be a couple of feet tall.
So what’s a bigger danger than something awful like the Great Recession? Investment experts talk about a human error called “policy abandonment,” which is a fancy way of saying that the investor bailed on the markets and generally at the wrong time. Suffering a significant decline in the Great Recession was temporarily painful. However, what about the people who abandoned their portfolio allocations and retreated to cash at or near the bottom because they just got too nervous about what the market would do the next day or the day after? They locked in those losses, moved to the sidelines and found themselves with permanent portfolio losses.
The lesson from the chart, as its author Chris Kacher points out, is that the stock market is driven over the long term by the intelligence, creativity, innovation and hard work that people working in various companies put into their jobs every day. The value of companies tends to rise. Yet fear sometimes makes people sell their stocks at lower prices, which up to now have always recovered to reflect that growing value.
The recent turmoil in the markets is certainly unsettling, but it’s nothing compared to the Great Recession, the Great Depression or likely the next significant bear market. That next downturn will present us with the illusion of danger (a temporary market decline) and some will take the opportunity to embrace real danger, which is the danger of “policy abandonment” that makes temporary losses permanent.
Bottom Line: What should keep you up at night when thinking about your retirement nest egg? Changing your long-term strategy because of short-term changes in the market.
The Dow Jones Industrial Average is a widely followed market indicator based on a price-weighted average of 30 blue-chip stocks that trade on the New York Stock Exchange which are selected by editors of The Wall Street Journal.
The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change with or without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.