It may seem counterintuitive, but tough times like these serve to highlight the benefits of staying invested during periods of volatility.
Historically, stocks have always recovered from previous setbacks and gone on to resume their general overall trend of price appreciation. Although past performance is no guarantee of future results, it's worth noting that while stocks have generated greater short-term risk than other investments, they have also achieved higher long-term average returns. Investors who feel tempted to cash out of equities in the wake of dramatic downswings should also consider the potential risks of abandoning ship and missing out on a possible recovery.
The chart below illustrates how investors who remained in the market during downturns since 1950 have benefited from subsequent recoveries. Between 1950 and 2010, there were 10 bear markets, defined as a drop of 20% or more from the market's previous high. During these bear markets, stocks fell an average of 34.2%. Yet they then gained an average of 136.2% in the subsequent bull markets, which are defined as the time periods between the end of one bear market and the beginning of the next.
Past performance helps to put it in perspective1
- From a historical perspective, the longer you stay invested, the less likely you are to lose money. For example, since 1926, investors lost money in 27% of all one-year holding periods. In five-year holding periods, they lost money 13% of the time, and in 10-year holding periods, they lost money 5% of the time. Investors who owned stocks for at least 15 years lost no money.
- Trying to “time the market” could cause investors to miss out on price increases and ultimately earn lower long-term returns. During the 20-year period from January 1, 1991, through December 31, 2010, missing the top 12 months would have reduced an investor's return from 9.14% to 3.81%. Between 1991 and 2010, missing the market's 20 best days would have dropped returns from 9.14% to 2.99%.
- A mixed portfolio allocated to different asset classes can lower overall portfolio risk, as measured by standard deviation, without sacrificing too much performance potential. For example, the annualized return for an all-stock portfolio during the 30-year period through 2010 was 10.72%. The standard deviation was 15.53%. On the other hand, the average annual return for a mixed portfolio (60% stocks, 30% bonds, and 10% cash equivalents) during the same period was 9.94%. The standard deviation was 9.81%.2
- Systematic investing through dollar-cost averaging can lower a stock's average purchase price over time, since more shares are purchased when prices decline and fewer when prices rise. This can potentially help mitigate the effects of a bear market. Because such a strategy involves continuous investment in securities regardless of price levels, investors should consider their ability to continue purchases through periods of increasing or declining prices.3
S&P 500® Index is an unmanaged index consisting of 500 stocks and is a widely recognized common measure of the performance of the overall U.S. stock market.
Past performance does not guarantee future results. Performance illustrated does not represent fund returns. There may be additional fees and expenses associated with investing in a mutual fund as described in the fund's prospectus. For current fund performance, please visit northernfunds.com.
Mutual fund investing involves risk, including the potential loss of principal. Stocks are more volatile and carry more risk and return potential than other forms of investments. Bonds offer a relatively stable level of income, although bond prices will fluctuate, providing the potential for principal gain or loss. Cash equivalents offer low risk and low return potential.
1 Source: Standard & Poor's. Based on total returns for 1926–2010. Stocks represented by the S&P 500 Index. Past performance is no guarantee of future results. All data and analysis is provided by Standard & Poor's.
2 Diversification does not guarantee a profit or protect against loss.
3 A periodic investment plan such as dollar cost averaging does not assure a profit or protect against loss.
4 Source: Standard & Poor's. Based on changes in the price of the index for 1950–2010. Stocks represented by the S&P 500 Index. Average bull market gain of 136.2% does not include market rise since March 9, 2009. Past performance is no guarantee of future results. Returns do not reflect the deduction of fees or expenses or the impact of taxes or other expenses. It is not possible to invest directly in an index.