Understanding Market downturns
Market Update
Rising inflation, rising rates, continued war, surging energy prices, talks of recession… the list goes on about what’s possible to worry about!
However, it’s times such as these, it’s important to focus on what is within your control and look through the short-term noise. While dramatic market losses can sting, it’s important to keep a long-term perspective and stay invested in order to participate in the recoveries that typically follow.
Don't make long term decisions on short term metrics.
Understanding market downturns
Nearly everywhere you turn, from friends and colleagues to news channels, you can find someone with a strong opinion about the financial markets. At the moment, it seems that the news on so many fronts is bad with skyrocketing energy costs and both equity and bond markets down significantly since the start of the calendar year.
While investing in the stock market is typically a prudent choice for investors seeking long-term growth, sharp drops can still be hard to stomach. Below are some things to keep in mind if a market tumble makes you feel the need to “do something” which might shut you out of the strong recoveries that have historically followed market downturns.
There has been a lot of focus on the transition to a bear market (with the line in the sand of a 20% decline having been triggered by the US S&P 500 index in mid June 2022). This is the same market that delivered returns of 36% for the year ended December 2021, and even with a 20% decline at the onset of the Covid pandemic, recorded 7.3% for the year ended December 2020.
It is important to keep in context that in spite of several bear markets, the market has also continued to trend higher over the long term. Not all financial market declines are the same in length or severity. For example, historically speaking, the GFC of 2008-2009 was an extreme anomaly. As challenging as that event was, it was followed by one the longest stock market recoveries in history.
The Australian equity market (which admittedly recorded a more modest, but still very respectable 17.5% for the year ended December 2021), has held up relatively well, posting a decline of 11% (so not yet in bear territory).
Dramatic market losses can sting, but it’s important to keep a long-term perspective and stay invested in order to participate in the recoveries that typically follow.
Some bear markets since 1980 have been sharp, but many bull market surges have been even more dramatic, and often longer, leaving stock investors well compensated over the long term for the risk they took on.
But such action would shut you out of the strong recoveries that have historically followed market downturns. The answer is to come up with a game plan before the next market pullback so you’re well positioned to try to take advantage of the opportunities that follow. What’s more, you’ll probably know what to expect as markets cycle through their phases, so you can tune out messages that don’t help your strategy.
Timing the market is futile
The best and worst trading days often happen close together and occur irrespective of the overall market performance for the year.
As the random patter of returns below highlights, predicting which segments of the markets will do well is also a tough order. Broad diversification keeps you from having too much exposure to the worst-performing areas of the market in the event of a downturn.
Source: Vanguard
https://www.vanguard.com.au/en
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