Stock market corrections are painful. How often do they happen?
Endowus Insights

Stock market corrections are painful. How often do they happen?

Updated
26
Aug 2022
published
31
Jan 2022
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stock market corrections - don't fear the markets

The original version of this article first appeared in The Business Times.

There is an old saying that goldfish have a mere 3-second memory. For the record, this is brutally unfair to goldfish, which have actually been researched to be very intelligent creatures with memories that can last into years.

I, despite having been through market corrections, studied the data, and systematically structured my wealth. But somehow I still feel like the unfairly treated goldfish with eyes bulging, aimlessly swimming back and forth in an anxious wreck, with a sour feeling in my belly.

Markets down this year more than they ever were in 2021

In January this year, the stock markets fell 7%. The biggest drawdown we've experienced so far is 12%. In all of 2021, the biggest peak-to-trough experienced was a mere 5.5%.

Many finance professionals like to use terms like "value at risk" or "standard deviation" to measure risk and volatility. While those metrics are important, I find the actual drawdown of a strategy, meaning the percentage loss from its peak to subsequent low, is much more tangible and a better indicator of the emotional rollercoaster of investing.

This is normal. Looking back at history, there is nothing unusual about what we are going through now. On average, stocks go down by 14% in any given year.

graph of global stock market returns & worst drawdowns

In over half of the years, at some point within the year, stocks have a drawdown of at least 10%. The year 2022 will be in this majority.

In over 20% of the years, stocks experienced a drawdown of more than 20%.

In over 10% of the years, stocks saw a drawdown of over 30%.

This is something all investors cope with again and again, with the expectation that they will be compensated with a higher return in the long run. Since 1990, if you had held on through nine years of negative returns — 17 years with drawdowns of more than 10%; four years with drawdowns of more than 30% — you would have had a bumpy but successful return of over 930%.

"Death of equities: how inflation is destroying the stock market"

This feels a bit like déjà vu.

It has been over 42 years since BusinessWeek showed crumpled stock certificates on its August 1979 cover proclaiming the death of equities in the US. It was in the following decade that gold hit a record, inflation was in the teens, and US stocks dropped over 20% on a single day now known as Black Monday. If you had held on to US stocks in this tumultuous decade, you would have had a handsome return of 388%.

If you had held on to stocks for the 42 years that followed the "Death of equities" and let the power of diversification and compounding work to your advantage, you would have had a return of over 12,000%.

Is now the time to jump in?

It depends. It depends on your goals and when you need to use the money. If you need to use the money in 2 years for a downpayment or significant purchase to enhance your quality of life, you should not jump into stocks now, if we were at an all-time high, or decade low. The diversion of outcomes in the short term is too random and such a goal would require a less volatile mixture of asset classes.

If you are saving and investing for a goal decades away, like your retirement, or your children, you can absolutely jump in now with time on your side, increasing your probability of success.

When to jump in does not depend on what I, your colleagues, or your smart friends who are "really into this stuff" think will happen by reading the macro signals, Covid situation, interest rate hikes, inflation, and more. No one can predict where markets will go in the short term. Your outcomes will be random and may fall short of your financial goals.

"HODL", with conditions

The purposefully mispelled "hodl", for those who do not know, is common in the crypto and investment blogger world to mean "hold on for dear life".

"Hodl" works when you have a well-designed and diversified portfolio, suitable for your goals, with low costs you understand.

I have seen many investment portfolios where "hodl" will not work — like if you have a hoard of stocks that have been bought on different tips and hunches, accumulated over a decade and looking like a concentrated and unplanned storeroom stuffed with things that no longer suit your life. Not cleaning up will only prolong the unproductive, underwater, and unenjoyable experience.

A common excuse I hear for not cleaning up is "I cannot sell now because it is below my purchase price". A reality check here — the market does not care about your profit and loss. If you paid too much for something, waiting around for someone to buy it from you at a higher price is wishful thinking.

You need an investment strategy that is future-proof, humble, strategic to your goals and passive in asset allocation so that you use markets to your advantage and can "hodl" through the volatility.

A feature of investing, not a bug

It will be hard not to talk about markets over the Lunar New Year holidays. That pain and doubt will be ever present, with short-term memory being so much more real than pretty charts that show us returns if we hold out over decades.

What we are going through is a feature of investing, not a bug. It is a conscious choice as an investor to tolerate these ups and downs for a higher expected return.

We humans, like the goldfish, deserve more credit for our memory and rational thinking. We can all get through this bumpy ride to wealth.

Next on the Endowus Fin.Lit Academy

Read the next article in the curriculum: Why Endowus Flagship Portfolios are our most popular solution

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