The Big Three: Time, Diversification, Volatility of Returns

“Doing well with money is not about what you know, it's not about where you went to school or how smart you are, it’s how you behave.” Renowned financial columnist, Morgan Housel, wrote this once and as recent market events have unfolded this statement cannot be more appropriate.

There is no doubt that emotions are high as market volatility continues, but as your advisor it is our job to help manage emotions and see the long term opportunity. As we discussed last week, it is not about timing the market, rather it is time in the market. 

The graph below tells a few stories. 

The first story is the story of staying invested in the market. Using rolling periods since 1950, a portfolio that is invested in only stocks (green bar) for one year has at best returned 47% and at worst negative 39%. Over 5 years, the best return has been 28% and the worst negative 3% (annualized), and so on. But over a 20 year period the best and worst returns are both positive at 17% and 6% respectively with an average annualized total return of 11.5% over 20 year periods. The longer time in the market, the more likely it is to have positive returns. 

The second story is the story of diversification. Diversification of a portfolio typically leads to less volatility. The graph above looks at a conservative portfolio comprised of 50% stocks and 50% bonds. Being invested for one year in a 50/50 portfolio the best return has been 33% (14% less than all stock portfolio) and the worst return has been negative 15 % (24% higher than the all stock portfolio). Over 10 and 20 years the 50/50 portfolio had only positive results, with an average annualized total return of 9% over 20 years. This is quite similar to the all-stock portfolio but with less volatility over time. 

Almost every year there is an external economic shock and the SP500 falls. There will always be a reason to sell. Thirteen years ago the market was in free fall when Lehman Brothers, the largest bank since before the Civil War, went under. But, as the chart below illustrates, the market has recovered from the bottom and returned nearly 400% over the next 13 years. 

The downturns are not easy to stomach and can be painful. In times like this it is most important to stick with your investment plan. If you are feeling uneasy and would like to reasses your plan, please reach out to us here at Westview. We are here to provide education, clarity, and reassurance.