Winter is Coming!

Winter Is Coming.jpg

By now you may be tired of talk of diversification and asset allocation. Surely there are more interesting things we can talk about with regards to investment? I agree, it can get pretty dry. However, there is a reason we keep coming back to these fundamentals: financial markets have different seasons, and the number one reason that people fail at investing is fear of winter:

Correction – when any market falls by at least 10% from its peak.

Bear Market – when any market falls by at least 20% from its peak.

Fear of these financial winters lead otherwise intelligent people to do some strange things. It wasn’t just stupid people that sold everything at the end of 2008 / early 2009. It wasn’t only fools who sat on the sidelines and did nothing as the market rebounded spectacularly through 2009 and beyond. So how do we overcome this fear of financial winter? Firstly, by understanding it better:

  • On average there has been a market correction every year since 1900.
  • The average correction over the last 100 years has been 13.5%.
  • From 1980 to 2015 the average drop was 14.2%.
  • Historically, the average correction has lasted only 54 days.
  • Less than 20% of corrections have turned into a bear market.
  • Historically bear markets have happened every 3-5 years.
  • Historically the S&P 500 has dropped on average 33% during bear markets.
  • In more than a third of bear markets it has dropped more than 40%.
  • On average, bear markets have lasted about a year
  • Bull markets tend to commence when investor confidence is at a low point.
  • The market hit bottom on March 9th 2009 – the S&P 500 surged 69.5% in the 12 months that followed.

(from Unshakeable: Your Financial Freedom Playbook by Tony Robbins)

You may be surprised to hear that corrections happen so frequently. This means the next one could come at any time. If you follow the news, and in particular the financial news, there are always multiple reasons to be fearful: terrorism, North Korea, conflict in the Middle East, slumping oil prices, budget standoffs, Brexit!

Then there are the doomsday guys who are forever warning of the coming crash. If you listen to these people you will never be able to get started investing. But how often are they actually right? Well if you consistently warn of a coming crash you will always be right eventually! Tony Robbins’ book has a brilliant section where he shows 33 instances of “experts” warning of a market downturn over a three year period, where the market actually went up instead.

Here’s the key: in the years 1980 to 2015, the S&P 500 experienced an average intra-year decline of 14.2%. However, the market ended up achieving a positive return in 27 of those 36 years. That’s 75% of the time. You cannot afford to be sitting on the sidelines while this is happening. In fact, the opportunity cost of doing nothing will cost you far more than any of the corrections, bear markets, and flash crashes:

“From 1996 through 2015, the S&P 500 returned an average of 8.2% a year. But if you missed out on the top 10 trading days during those 20 years, your returns dwindled to just 4.5% a year. Can you believe it? Your returns would have been cut almost in half just by missing the 10 best trading days in 20 years! It gets worse! If you missed out on the top 20 trading days, your returns dropped from 8.2% a year to a paltry 2.1%. And if you missed out on the top 30 trading days? Your returns vanished into thin air, falling all the way to zero!” (from Unshakeable: Your Financial Freedom Playbook by Tony Robbins)

So we need to understand that winter is just one of four seasons and get back to the boring stuff: understand your risk profile, get your asset allocation right, rebalance annually, and ignore the noise!

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