As you looked at your investment accounts at the close of 2018, you may have been thinking “Wow, I just lost most of what I made in the previous year.” We all know that feeling of “one step forward, two steps back.” However, sometimes we just need a little altitude to get some perspective.
No one likes to see the value of their investments go down. However, it does help to take a more comprehensive look at the stock market over time. To begin with, 2018 was the first year of negative returns from the stock market since 2008 (as measured by the S&P 500 Index, which tracks the performance of the 500 largest companies in the United States). If we look back a little further, over the last twenty years, we can see that the stock market lost value in five of those years. In fact, over the last 100 years, the stock market has lost value on average in about one in every four years – 25% of the time. This is a very normal pattern and part of a healthy market that is constantly reevaluating stock prices based on expected future earnings. All but the newest investors have experienced a market downturn. Admittedly, it may feel different this time because we went nine years without a negative year.
The talking heads on TV have been coming up with all kinds of reasons for the drop in the stock market: President Trump, trade wars, the Federal Reserve raising interest rates, slowdown in the world economy – the list goes on and on. All of this is true; these things, and literally thousands of other things, do have an effect on stock values. However, unless you are trying to time market ups and downs (which I advise against), the reasons behind these sometimes dramatic stock value fluctuations are usually not that important. It is far more important to have a well-thought-out financial plan and to ensure that your investments in the stock market are part of your long-term asset strategy. Never keep money you may need in the short term (five years or less) in the stock market –you never know when these loss years will occur.
In 2018, the S&P 500 Index had a negative return of 4.38% including dividends. Your own stock investments likely dropped significantly more, and you may be wondering why. Hopefully, you don’t have all your stock investments in just one part of the market, say, U.S. large companies, which is all that is included in the DOW Jones and S&P 500 Indexes. Even though these large companies were down in 2018, they did much better than other parts of the stock market. For instance, U.S small companies (Russell 2000) returned -11.01%, while international small companies (MSCI EAFE Small Cap) returned -17.89% and real estate investment trusts (Dow Jones U.S. REIT) returned -4.22%. So, if you have a well-diversified stock portfolio, your return should be worse than the negative return reported in the news for the DOW and S&P 500.
That leads to another question: “Why would I want to own all of these different stocks if they made my return lower?” Again, getting a look at the bigger picture is helpful. Here are the average annual returns on each of these groups of stocks over the last 20 years:
5.62% - U.S. Large Companies
7.40% - U.S. Small Companies
7.36% - International Small Companies
9.83% - Real Estate REITs
As you can see, over the long term, a broadly diversified mix of stock investments helps you achieve higher returns and will increase your odds of achieving your goals.
Here’s one last thing to keep in mind. During large drops in stock market values, you may be tempted to sell. However, before you do, ask yourself one question: “If I’m selling my stock, who am I selling it to?” After the recovery from every major drop in the stock market, there are always stories about how the rich get richer and benefited from the last market correction while the typical investor lost money. To a large degree, this is because when ordinary investors panic and sell, the people they are selling to are most likely more experienced, more patient investors who understand market swings and have a long-term perspective.
Just remember one simple rule: keep short-term assets (like short-term, high-investment-grade bonds, bank CDs, and savings accounts) for all your cash needs over the next five years, leave your diversified stock investments for your long-term needs, and don’t forget to rebalance each year. Sometimes we all need to gain a little altitude to see the big picture. Taking a long-term perspective helps us see more clearly where we are going and makes it easier to stick to our plan.