The stock market continues an impressive recovery after the low in March of last year. However, according to Yale University’s Crash Confidence Index, only about 27% of investors are confident the market will not correct sometime during the next six months.
If fear leads investors to avoid the market all together, they may limit their potential returns.
For example, during the 20-year period ended December 31, 2018, stocks had an average annual return of 7.2%. By comparison, bonds returned 5.5% and cash 1.8% during the same time frame. During that 20-year stretch, stocks outperformed bonds and cash in 14 years out of 20.
The stock market can be volatile. Between October 9, 2007 and March 9, 2009, the S&P 500 stock index shed over half its value. But then the S&P 500 started clawing its way back and ended 2010 within 20% of the October 9, 2007, close. If the impulse to be safe keeps investors out of the stock market, it also keeps them from taking advantage of the returns the stock market has to offer. This can potentially affect one’s long-term financial goals much more than avoiding a short-term decline. Yes, you may have avoided the drop, but what are you costing yourself over a 20-year period (or other lengthy period of time)? Potentially thousands.
Cash alternatives – the most conservative of the three major investment classes – outperformed stocks and bonds only twice during the 20-year period in question. A prudent investing strategy considers short-term volatility without losing sight of long-term objectives.
A sound strategy usually involves diversifying capital between different classes of investments. That way, under-performance in one type of asset may be offset by the positive performance of another. While this short blog focuses on the differences in three main asset classes, further diversification comes from looking at many sub asset classes and sectors within each of the classes.
Bear in mind, though, that diversification and asset allocation are approaches to help manage investment risk. They do not eliminate that risk all together. The asset class that performs best one year may not do so the next. In fact, history shows that it usually doesn’t. Diversifying your holdings among several different investment types and understanding that asset classes can move in and out of favor can help you manage the risk in your investment portfolio.
Are you hurting your long-term goals by trying to avoid a stock market drop? Let’s talk through it. Call upon us anytime.