Recent headlines about the stock market probably made the hairs on the back of your neck stand up. But a wider view makes clear there's no need to be spooked.
“October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” -- Mark Twain
Halloween came several months early this year — at least with respect to your investment portfolio. Here’s what one headline said back in August during the summer’s market downturn:
“The Dow’s more than 1,000-point drop this week was the largest weekly drop since the week ended Oct. 10, 2008” (Source: The Wall Street Journal, Aug. 21, 2015)
That headline and your portfolio’s recent losses probably made the hairs on the back of your neck stand up, but I want to tame your emotional demons by looking at what returns you should expect from time to time. I’ll use two different asset classes: US stocks (S&P 500 Index) and international stocks (MSCI EAFE Index). Most investors focus on the average annual rate of return and think that’s what they’ll get every year:
But they fail to realize that in any given year the returns can be much higher or lower than that average. It’s sort of like diving into a swimming pool. The average depth of the pool might be 6 feet, but one end of the pool might only be 3 feet and the other end might be 12 feet. Stocks have had a wide range of returns as seen here:
US stocks have swung from nearly +40% gains in one year to -40% losses in another year. International markets have been even more volatile.
If that bothers you, then you should reduce your exposure to risky asset classes. The best way to do that is to add bonds to your portfolio. Unfortunately that still doesn’t take away all the pain.
Here are the average annual returns, best return, and worst return of a portfolio of 50% stocks equally split between US and international stocks, and 50% bonds:
You still lost almost 20%.
What does all this mean and how do you apply it to your investment portfolio?
1. Expect big losses in your portfolio from time to time
2. Realize that losses are “normal”
3. If you can’t stand these losses, ï¬gure out how much you can handle and then design your portfolio accordingly
4. If you have a ï¬nancial advisor, ask him what potential losses to expect in your portfolio (I bet you he hasn’t discussed this with you and only touts gains — am I right?) If you do all of the above, then hopefully Halloween next month will be a lot scarier than the ups and downs of your portfolio.
Setu Mazumdar, MD, CFP® is board certiï¬ed in EM and he is the president of Physician Wealth Solutions.