Market Declines are Normal
The S&P 500 Index closed 2021 at 4,766. On January 24, 2022, it hit a low of 4,223, a drop of 11.4%, qualifying as a correction (the conventional definition of a correction is a drop of at least 10%). Drops of this magnitude can cause investors’ stomachs to roil, often leading to panicked selling. Investors might be able to avoid that mistake if they understood that drops of that magnitude occur fairly frequently – they are “normal.”
To demonstrate this point, in its monthly field guide, Avantis showed that over the period 1926-2021, the S&P 500 experienced 29 declines of at least 10% – about once every four years. The median drop among this sample was -20.1%, and the median length of time it took for the market to return to its previous high was 194 trading days (the fastest time to recovery was just 50 days). Drops of at least 5% occurred 90 times (almost once per year on average), with an average decline of 8.9% and the average time to recovery of 62 days. Drops of at least 20% (the conventional definition of a bear market) occurred 15 times (about once every six years), with an average decline of 28.2% and the average time to recovery of 369 days (just over a year).
Significant declines are not rare events. They happen fairly frequently, and in many cases, markets recover reasonably quickly. In other words, normal times include sharp market declines and periods of higher anxiety that should be borne with equanimity, as the evidence demonstrates that efforts to time the market are highly unlikely to prove productive. Knowing your financial history will help you keep your equanimity.
Since 1950 there were nine months when the S&P 500 Index lost at least 10%. The worst loss, -21.5%, was in October 1987, and the average loss was -13.7%. Over the next three, six and 12 months, the S&P 500 Index provided total returns of 9.5%, 16.4% and 26.6%, respectively. Investors who abandoned their plans due to panicked selling not only missed out on those great returns, but they were then faced with the extremely difficult decision of determining when it was safe to get back in. That’s one of the problems with market timing – you have to be right twice, not once. Return