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Ready for this year’s market declines?

Jan. 22, 2014
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By Dan Crimmins

Learn more about Dan on NerdWallet’s Ask an Advisor 

The 2013 financial stock market results are in. For those investors who have remained disciplined and focused on their long-term goals, 2013 was a good year indeed. The S&P 500, the index that tracks the performance of the largest U.S. stocks, gained nearly 30% in 2014 while the MSCI, which tracks the performance of the international developed markets (excluding Canada), gained 23%.

However, only investors who stayed patient and disciplined throughout the year, and had invested the money before the year began in these asset classes realized these 2013 stock market gains.  I was asked late in the year by one investor “what did the stock market surge mean for his 401(k) plan?”

I stated, “It depends – does your asset allocation include investing in these companies?” “No” was his answer as he invested only in cash and bonds. Thus, he missed the gains posted over the year in the stock market.

Why was he invested only in a bond/cash portfolio? Fear of course: The culprit – Fear of stock market volatility – the up and downs of the marketplace. He retreated to a “safer” portfolio after the market meltdown in 2009. This recent meltdown – that ended in March 2009 – is still on his and other people’s mind.

So – are you ready for this year’s market declines?  This is not a forecast because the stock market regularly declines during each year which only exasperates the fear.  Each yearly predictable decline is discussed in the media as the potential coming of the next “market crash,” followed by stories of what investors should do now to “protect” themselves.

For even when the S&P 500 Index gained 30% in 2013, this same index declined 6% during the year. Was the decline the result of the now forgotten story regarding the bailout of the tiny island of Cyprus in March? No – it was at the end of September amid bad news in Kenya and during the U.S. government shutdown.

However, yearly market declines are commonplace.   The chart below shows that over the last 34 years the S&P 500 index has had annual positive returns in 26 of those years.  However, the average intra-year drop was 14.4% during this period (not including dividends received). Therefore, in nonprofessionals’ terms, at some point on average, the S&P 500 index had declined over 14% during the year even as the index was in route to an annual gain for the calendar year.

On page 16 of J.P. Morgan Asset Management’s 2014 1st Quarter Market Insights, a chart shows intra-year stock market declines (pink dot and number), as well as the market’s return for the full year (grey bar). What is clear is that the market is capable of recovering from intra-year drops and finishing the year in positive territory, which should encourage clients to stay the course when markets get choppy.

Therefore, the price for “ignoring” or at least staying disciplined and patient during all of these yearly declines was capturing returns of 1,689% during this time. As the S&P 500 index rose from 106 at the beginning of 1980 to close on December 31, 2013 at 1,848, without even including the benefit of receiving dividends.

If you have a plan, your plan should include the realization that short-term market volatility has been consistently rewarded in the long term.  The payoff for maintaining your stock exposure for the long-term will result in you being able to capture these capital market gains and help you live the life that you envision. Ensure that your investment portfolio — especially your 401k plan — has a significant allocation to the global stock markets in order to reach your desired goals. Work with an advisor who will help you set the proper allocation and then help you stay disciplined and patient during the market declines that will occur this year and every year.