When markets are in turmoil, it’s very tempting to forget the long term picture and the achievements of the past, and feel you simply must do something to end the current pain. This is how too many investors lose their hard earned money: first, by selling at the wrong time, and then by missing out on the eventual recovery and future gains their investments would have offered had they kept their emotions in check.
It takes patience to be a successful investor. But each time we have a market downturn, you begin to hear same, almost verbatim conversations. Things like: “This correction is different,” and “The old rules of investing no longer apply.” The way forward, some people argue, must be different too.
Corrections Are Common
Stock corrections, defined as a 10% or more decline in share prices, are quite typical in financial markets. Since 1928, global stocks have offered an average annual return of 10%, even though forty percent (40%) of that time, stocks were in a correction . Think about this for a minute. Forty-percent of the time, your account value would have been going down, and yet, patience and discipline delivered a phenomenal compounded return. The obvious conclusion is that stocks have far more up periods than down, and the up periods tend to be larger.
Any close study of financial history over various periods reveals the same thing. Corrections are common. Since 1980, the global stock market has experienced 12 corrections and 7 bear markets—on average, a stomach-churning downturn happens every 2 years or so. Over the past 36 years, stock prices have spent almost 30% of the trading days in corrections or bear markets. The average length of the correction was 87 days, and the average time to recovery was 121 days.
Patience and Discipline Pay
More recent history still suggests that the tried and true methods of diversification, and rebalancing to buy-low and sell-high, tend to work better for investors than trying to predict the future. For example, the S&P 500 had a negative return in 2000 (-9.10%) after three full years of heavy losses. Many investors bailed out of stocks and never came back. They then lost out on the next 13 years of 8.90% annualized returns. During 2008, in the depths of the financial panic, the S&P 500 fell 37%. But after that crash, patient investors who stayed the course were rewarded by seven years of positive returns.
It’s Always Surprising…But The Reaction Is Rarely Different
History does not predict the future but there are some remarkable similarities in how markets and asset prices respond to the vagaries of the daily headline news. In each correction or bear market, a surprise catalyst is revealed that had not yet been factored into market prices, and then the inevitable setbacks occur. Volatility rises, prices drop and then eventually buyers step back in to drive prices higher. Then the cycle repeats, and historically, this has resulted in an upward trend and gradual increase in asset prices. So, while the catalyst for each correction or bear market will vary, the reaction is quite predictable. Patience and discipline are an investor's strongest allies for riding through periods of market anxiety, and provide the best chance for coming out the other side richer for the experience.
 Average annualized returns, January 1, 1928 – December 31, 2015: U.S. stocks = 9.72%; U.S. bonds = 5.41%; cash = 3.49%. Stocks are represented by S&P 500 Index. Bonds represented by Standard & Poor's High Grade Corporate Index from 1926 to 1968, the Citigroup High Grade Index from 1969 to 1972, the Lehman U.S. Long Credit Aa Index 1973 to 1975, and the Barclays Capital U.S. Aggregate Bond Index thereafter. Cash is represented by U.S. Treasury bills.
 As represented by the MSCI World Index from January 1, 1980, through December 31, 1987, and the MSCI AC World Index thereafter.