Stock market volatility will always be a major concern for self-directed investors since it affects the return on their investments.
Because financial markets are influenced daily by economic, geopolitical and financial news, they’re constantly adjusting to investors’ consensus on the price of assets such as commodities, company shares, fixed-income securities, real estate, etc.
The stock market is hardwired for ups and downs. To properly
interpret the return on your investments, you need to look at stock
market behaviour over time. According to the 2016 edition of the
annual Andex Charts, the
average return on Canadian and U.S. equities has varied between 9.5
and 11.5% since 1950. That means an $100 investment in the S&P 500
in 1950 would have been worth more than $115,000 by 2016 (1,150 times
the initial outlay). This result demonstrates the value that stocks
can create for long-term investors.
However, the stocks’ trajectory while generating that average return was quite erratic. PWL Capital made some very interesting observations about this past performance in June 2015. Its study showed that a balanced weighting of Canadian, U.S. and international equities would have produced an annual return in the 6 to 11% range in only five of the years since 1970. In other words, the annual return on this stock portfolio was in the “normal” range only one time out of 9!
In fact, returns that could be qualified as “abnormal” were much more frequent during that same period:
Market returns were above average 3 times out of 5. The same type of behaviour has been observed over a much longer period (since 1926), as explained in Ken Fisher’s book Debunkery.
This information is crucial for investors. And if they’re nearing retirement or have other financial goals in mind, they’re sure to have concerns and doubts about uncertain or occasionally negative stock market returns when they’re expecting average returns to range from 6 to 11%. That’s why avoiding the stock market altogether and falling back on products with guaranteed capital (but which offer much lower potential returns) will be a common reflex for many investors.
Here’s where the principle of diversification becomes so important. It always bears repeating that diversification is the only way to lessen the risks in your portfolio. Simply adding different stocks is not enough. Other assets such as bonds, real estate, alternative investments and foreign currency holdings can smooth out the fluctuations in your portfolio because these asset classes are not closely correlated to the performance of stocks. With exchange-traded funds, you don’t need to be an institutional investor to have access to these investment vehicles. Check out NBDB’s Exchange-Traded Funds page and discover how much diversification this type of product offers.
Remember, past returns do not guarantee future returns and, by including more investments with different correlations in your portfolio, you can lower your risk and come out ahead. It’s up to you!
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