If there’s one thing that makes investors nervous, it’s market volatility. Wild swings in stock prices can tug at our emotions and tempt us to make hasty decisions that run counter to our goals. And when things get really bumpy, as they did earlier this year, some investors might be tempted to pull out of the market altogether.
But keeping even the worst bouts of turbulence in perspective can be good for both your nerves and your portfolio. Yes, stocks tend to be riskier than other investments, but they also have the potential for higher reward. In fact, research shows that stocks tend to outperform other asset classes over the long term, and they far outpace inflation, as well. From 1970 through 2014, for example, large-cap stocks generated annual compounded returns of 10.5%, while bonds generated returns of 7.9% and inflation averaged 4.2%.1 Importantly, that time frame included two extremely challenging periods for stocks: the tech bubble and subsequent bear market of the early 2000s and the Great Recession of 2008–2009.
Of course, you can’t take advantage of such gains if you’re not invested—and that means staying invested during periods of increased volatility, however counterintuitive that may sound. In fact, we’ve run comparisons between hypothetical portfolios and found that people who stuck to a regular investment plan even when markets were going haywire enjoyed greater returns than those who pulled out when things got rough.2
Buying stocks is the best way I know to achieve growth. I also believe that investing is an act of optimism—optimism and belief in the growth of our country, our economy and the companies that drive it. Sometimes maintaining that optimism means you have to look beyond the turbulent present and focus on the future. After all, growth is rarely a short-term affair.
If you find yourself concerned at the first sign of market volatility or tempted to pull out of the market altogether, you may be taking on too much risk in your portfolio, and it’s probably a good idea to revisit your asset allocation. Check to make sure that your overall allocation still reflects both your willingness and capacity to take on risk, and that you’re not overexposed to any one asset class.
And take heart: No bear market yet has been severe enough to knock stocks off their long-term rise. As investors, we know the markets will test us sometimes. How we respond could be the difference between a success or a stumble.
Charles R. Schwab
Founder & Chairman
1 Charles Schwab Investment Advisory, Inc., as of 12/31/2014.
2 The example measured how three hypothetical portfolios grew as three individuals invested 10% of their annual salaries in increasingly conservative asset allocations over time. Each investor began with a salary of $18,580 in 1973 that grew to $100,000 in 2008 based on a 3% annual increase and a 10% promotion every five years. The hypothetical investors began at age 26 with the Schwab Aggressive Model Plan (50% large-cap stocks, 25% international stocks, 20% small-cap stocks, 5% cash), shifted to the Moderately Aggressive Model at age 39 (45% large-cap stocks, 20% international stocks, 15% small-cap stocks, 15% bonds, 5% cash) and moved to the Moderate Model at age 52 (35% large-cap stocks, 15% international stocks, 10% small-cap stocks, 35% bonds, 5% cash). The asset allocation plan performance was the weighted averages of the performances of the indexes used to represent each asset class in the plans, and the plans were rebalanced annually. Fees and expenses would lower returns. Past performance is no guarantee of future results. U.S. large-cap stocks are represented by the S&P 500® Index. U.S. small-cap stocks are represented by the Russell 2000® Index, and the CRSP 6-8 was used prior to 1979. International stocks are represented by the MSCI EAFE® net of taxes. Bonds are represented by the Barclays U.S. Aggregate Index, and the Ibbotson Intermediate-Term Government Bond Index was used prior to 1979. Cash equivalents are represented by the Citigroup 3-Month U.S. Treasury Bill Index, and the Ibbotson U.S. 30-day Treasury Bill Index was used prior to 1978.