How concerned do we need to be about market declines?

May 01, 2018 | Alan MacDonald


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The current threats of global trade wars, heavily indebted consumers and populist politicians might be reasons to worry, they’re probably not reasons to panic, sell growth investments in favour of bets like gold or stow your cash under the mattress.

In the past, stock markets around the world have survived world wars, hyper-inflation and any number of bank and government insolvencies. So while the current threats of global trade wars, heavily indebted consumers and populist politicians might be reasons to worry, they’re probably not reasons to panic, sell growth investments in favour of bets like gold or stow your cash under the mattress.

Using history as a guide, we can see that market set backs are fairly common, but quite temporary.

I asked our friends at Dimensional Fund Advisors (DFA) to put together a 20-year history of what a globally diversified all-equity portfolio would look like both on a year-by-year basis and on a cumulative return basis. The figures below assume investment management fees equal to 1.44% of the total amount invested. They reflect a one-third weighting to each of the DFA Canadian equity index, the DFA U.S. index and the DFA international index. It’s also assumed that, at the end of each year, the portfolio was restructured to maintain this equal weighting of one-third of total assets being held in each index.

Year  Annual Return%

1998       11.78

1999       17.22

2000       4.44

2001      -2.33

2002      -12.34

2003       19.55

2004      13.22

2005      14.75

2006      18.49

2007      -4.24

2008     -30.85

2009      26.50

2010      13.84

2011      -7.85

2012     10.55

2013      26.61

2014      9.08

2015      5.38

2016      12.99

2017       12.4

Annualized return  = 6.96%

 

There are a few observations to be had from the chart above. The first is that there are five negative years out of 20. This suggests that waiting for a bad year to invest is playing some pretty bad odds – you have a much better chance of being wrong than being right.

The second observation is that you don’t have to wait that long for markets to right themselves. Even the once-in-a-generation market meltdown of 2008 produced two negative years and then the upward march continued.

Of course, knowing that market corrections are short doesn’t make them any easier. As one market commentator pointed out – market corrections are like having your head held underwater, it may not be a long time, but if you don’t know when it ends it will feel like forever.

There is good reason, however, to endure the discomfort. Stocks provide the highest return of any asset class. They are one of the few ways open to us to truly beat inflation and help both our money and income stand up against the needs of 30 year retirements.