Volatility: The Investor's Forgotten Friend

Volatility: The Investor’s Forgotten Friend

Investment markets have been very kind to global equity investors over the last two years. After a period of sideways markets and soaring inflation, the S&P 500 (the world’s premier stock market) rose by 24% in 2023 and another 23% in 2024.

With historical average returns in the 8-10% range, these are extraordinary returns that patient and disciplined investors will be delighted with.

Most significantly, the last two years saw no extended periods of significant declines.

In 2023, the largest decline was -10% between July and October. In 2024, the worst was a 21-day decline of only -8% between July and August.

While this was a welcome respite from the normal market rhythm, the financial media would likely have been dismayed! More seriously, there’s a danger that investors will forget the important lessons learnt from past declines.

To prepare you for the possibility of more significant declines in the coming year, I shall outline a few points below that you should keep in mind when others are losing theirs.

What You Should Know

It is a feature of the stock market that values do not move in a straight line but instead fluctuate around a generally upward trend. We refer to this as “volatility.”

A market correction is defined as a 10% drawdown from a previous market high. While it may sound like a significant number, these events occur far more frequently than most investors believe. Indeed, they come around as often as your birthday, with years like 2024 being the exception.

Since the turn of the century, the average annual decline has been approximately -16%. While this may surprise you, it’s worth noting that about three in four years still ended with a positive return.

We also know from market history that we expect a decline of more than -30% approximately every five years (on average), as we last experienced in 2020.

How You Should React

We know that stock markets generally provide positive returns about three in every four years. The one negative year is what earns you the other three positive years. It’s the price of admission for profiting from the collective ingenuity of the hundreds of companies working for you while you sleep. I encourage you to see the temporary declines as the reasonfor the stock market’s permanent returns. You can’t have one without the other.

Unfortunately, we cannot consistently predict when these fluctuations will occur or when they will reverse. To be a successful long-term investor, one must accept this with humility.

Market declines will consistently occur throughout your investing life, and your mindset during these times is a choice that will shape your financial future. I advise you to confront them with confidence rather than fear while being mindful of the opportunities they present.

Time Heals

Ultimately, what happens in the next year is relatively unimportant to your 30-year plans. If you’re investing long-term, then it is likely the odds will be in your favour. However, this is never guaranteed.

After two years of little volatility, if we experience a decline in the coming months, be encouraged that you are busy earning future returns. Additionally, if you’re still saving, declines are your best friend, allowing you to buy more units of shares at reduced prices.

We don’t know where the market will be at the end of 2025, but we do know that time is the enemy of market declines and most investors have plenty of time.

Until next time,

Eugénie

·  The value of investments and any income from them can fall as well as rise. You may not get back the full amount invested.

·  Past performance is used as a guide only; it is no guarantee of future performance.

·  This guide is for information purposes and does not constitute financial advice, which should be based on your individual circumstances.

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