Finding Perspective on Volatility

While my goal when I communicate with you is to convey complex topics simply, once in a while, it’s helpful to go a bit deeper to drive home an important concept. But please stay with me. I’ve had a few discussions lately that made me realize that a reminder like this is helpful.

Since 1965, the annual total return for the S&P 500 Index has averaged 11.2%, with the best return of 37.2% occurring in 1995 and the worst return of -36.6% occurring in 2008. On a side note – while 2008 was a wretched year and nearly all asset classes took a temporary hit, stocks did bounce back nearly 26% the following year.

Over those 50 years, 39 were in the green (78%) and 11 were in the red. So far, this is pretty straightforward and supports the argument that stocks have a place in most portfolios, assuming at least a medium timeframe.

Now it’s time for a slightly deeper dive before I pull it all back together.

Since 1965, the standard deviation (a common measure of how variable returns of a particular asset are) of the annual 11.2% return has been 17%, which means that about 67% of all annual returns should fall between 11.2% plus or minus 17%. Or a range of -5.8% and 28.2%.

If we go out two standard deviations, about 90% of all annual returns should fall between -22.8% and 45.2%.

In reality, we experienced only two of the 50 years outside the range, with both years coming in below -22.8%.

What does all of this mean?

Time to get practical and extract ourselves from the numbers.

This is a high-level review of S&P 500 stock returns and volatility that surround the average annual returns. Some investors easily look past such volatility while others experience sleepless nights at the thought of their portfolio losing “two standard deviations” in one calendar year, even if the odds are low.

Only you know how you will react. That’s why I counsel – Investor, know thyself!  We have had more discussions around the new technologies of risk scoring of portfolios to try to make sure that client’s portfolios match up with their understanding of their situation.

When we are young and may not need any cash for decades, it is usually wise to focus on growth, which carries more risk.  But as we age, preservation of capital, quick access to our funds, and regular income become equally if not more important for many.

The current correction has had less impact on those who have reduced exposure to stocks, but these portfolios trade a reduced long-term expected return for a smoother ride of returns.

Bottom line

Benjamin Graham, known as the “Father of Value Investing” and a favorite of Warren Buffett, once said, “Individuals who cannot master their emotions are ill-suited to profit from the investment process.”  Diversification and an investment roadmap that takes the emotions out of the investment equation have typically been the surest path to financial success.

While it’s easy to adhere to the investment plan when times are good, some investors find it difficult when the road gets a bit rocky.  It’s during times like these that detours tempt the investor. In most cases, however, you’ll wind up in an unfamiliar neighborhood, and the delay will cost you precious time.

In closing, I trust that you have found the September summary and this big picture view to be beneficial and educational. As always, I am humbled that you have placed your trust in my firm. It is something I never take for granted.

I always emphasize that as your financial advisor, it is my job to partner with you. If you ever have any questions about what I’ve conveyed in this month’s message or want to discuss anything else, please feel free to reach out to me.

Data Source: Horsesmouth October client letter