Markets are off to a bumpy start so far this year, and many investors are concerned about what this means for their investment portfolios. Indeed, record-high levels of inflation, the likelihood of rising interest rates, and the ongoing Russia-Ukraine conflict are causing fear and uncertainty in financial markets. But just because market turbulence is uncomfortable doesn’t mean it’s time to panic. If you’re a long-term investor (i.e., you don’t need to access your funds for at least 10 years), it’s important to keep market volatility in perspective.
WHAT’S CAUSING RECENT MARKET VOLATILITY?
Rising inflation has been a source of concern for investors since the start of the year. Ongoing supply chain issues and labor shortages due to the Covid-19 pandemic sparked an uptick in prices beginning in early 2021. Though the Federal Reserve initially dismissed rising prices as transitory, it has since adjusted its stance. Now, it seems likely the Fed will raise interest rates 0.25% this month.
However, the Fed has been very transparent about its intention to increase interest rates. Consequently, markets are unlikely to react strongly to the news if the Fed proceeds as planned. Instead, investors remain focused on the conflict in Ukraine, which has caused a surge in oil prices and pushed U.S. stock prices lower.
GEOPOLITICAL EVENTS & THE U.S. STOCK MARKET
U.S. stocks have been on a rollercoaster ride since Russia invaded Ukraine. And while volatility is unsettling, it’s not unusual given the many uncertainties this conflict creates. Though we don’t know how this will play out, nor do we know how long it will last, we are likely to see more volatility in the near-term.
On the bright side, stock market volatility has historically been short-lived following geopolitical events. In the United States, the median stock market drawdown due to geopolitical shocks was -5.7%, according to data from Deutsche Bank. Moreover, these drawdowns tend to take around three weeks to reach a bottom and an additional three weeks to recover. On average, the market was 13% higher from the bottom 12 months after.
Other data shows that since World War II, U.S. stocks were higher three months after a geopolitical shock, on average. And following about two-thirds of those events, they were higher after only one month.
WHAT DOES MARKET VOLATILITY MEAN FOR LONG-TERM INVESTORS?
Unfortunately, volatility is the price investors pay for investing in stocks. But the good news is long-term investors tend to be rewarded for enduring these periods of discomfort. Finance professionals refer to this concept as the equity risk premium. Investors can expect to earn a higher rate of return on stocks over time to compensate them for taking on higher levels of risk.
In fact, the average annualized return of the S&P 500 Index since its inception in 1926 through the end of 2021 is 10.5%. That includes every correction and bear market since the index’s inception.
In other words, while volatility is an ever-present force, the equity risk premium endures. It’s this trade-off that allows long-term stock investors to outpace inflation and grow their financial resources for the future. Moreover, volatility often provides investors with the opportunity to purchase stocks at discounted prices, which can boost returns over time.
BOTTOM LINE: STAY THE COURSE
Historically, investors who stay the course during periods of uncertainty ultimately reap the rewards. We have no reason to believe this time will be different.
If you’re considering abandoning your investment plan, turn off the news and focus on what you can control instead. In addition, avoid checking your account balances too frequently. This may provoke you to make unnecessary trades that aren’t in your best interest. Lastly, consider working with a trusted financial advisor like Sherwood Wealth Management, who can help you develop an investment strategy that’s aligned with your goals, time horizon, and tolerance for risk.
This article was also featured in the Post Independent.