26 August 2015

Putting This Wild Stock Market in Perspective

This last week has been brutal for markets, The S&P 500 has been jumping around by as much as 4% a day, and a great deal of it down.

So is the market in trouble? Should you flee to the hills to buy gold?

If your investment horizon is years or decades - as it is for most of us saving and investing in hopes of someday retiring - probably not.

While the market is moving as much as 4% a day, it is only down 2.3% from a year ago as of today's close. (And with the market so volatile, there is a very good chance that this will round to zero by tomorrow's close or be down by double or triple that.) That's pretty close to no change for the year. Still, it is 19.3% higher than it was two years ago, and 76.6% higher than it was five years ago.

Up 76.6% in the last five years works out to about 12.1% average annual return. Up 19.3% for the last two years works out to an average annual return of 9.2%. That's right. Even with the last week's "mini-crash" and this last year's negative return of 2.3%, annual return is still 9.2%.

That's nice. And not outrageous. Most studies show long-term returns of 6 to 8% for the markets. It makes sense that returns in the last 5+ years would be slightly higher than average given it came off a market that had fallen by half.

If you are saving for a retirement that is still five to 35 years off, 9 to 12% is a pretty good return. And with returns that consistently high for the last 5+ years, it really is no wonder that the market is pausing in the midst of what has been a steady upwards trend to have a year in which market movement is close to zero.

Is this a bubble bursting? More likely it is a strong return being adjusted downwards slightly. Short term, markets behave irrationally, jumping up and down like over-sugared kids at a party. Long term, though, they tend to make sense. And with employment, GDP, and profits steadily growing over the last 5+ years, it makes sense that the market has moved upwards. Given how slowly all three have moved upwards, though, it also makes sense that investors wouldn't bid up the price of stocks every year, hence, this year of uncertain returns.

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